39 - 1992 Spring

SPRING 1992 ISSUE 39
A PUBLICATION OF THE MARKET TECHNICIANS ASSOCIATION

71 BROADWAY, 2ND FLOOR, C/O NYSSA l NEW YORK, NEW YORK 10006 l (212) 344-l 266
MARKET TECHNICIANS ASSOCIATION JOURNAL
Issue 39 Spring 1992
Editor
James J. Bohan
Merrill Lynch
New York, New York
Associate Editors
John R. McGinley Michael J. Moody, CMT

Technical Trends Smith Barney Harris Upham
Wilton, Connecticut Los Angeles, California
Manuscript Reviewers
Frederick Dickson, CMT David Upshaw, C.F.A., CMT

TDA Capital Waddell and Reed Investment Management
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Henry 0. Pruden, Ph.D.

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MTA JOURNAL / SPRING 1992 1

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TABLE OF CONTENTS
Instability in the Moving Window Correlation

Stock Market .. .. . .. .. . .. .. .. . .. . 9 Stability and its Use in
Richard C. On; Ph.D. There appears to be Indicator Evaluation . . . . . . . . . .21
recurring patterns in markets and just about David Aronson One way to determine the
every natural phenomenon. Patterns don’t usefulness of an indicator is to correlate the
repeat in exactly the same way, however, and indicator with the future performance of the
we need indicators to provide a warning when market. David Aronson carries the concept
the market might be sensitive to external a step further by showing how the indi-
stimuli. Dick Or-r provides us with a tech- cator’s relationship to the market changes
nique, utilizing the concepts of volatility and over time and by providing an estimate of
instability, to judge the stock market’s vul- the indicator’s stability. A method of combin-
nerability to shock, based on the concept of ing indicators that have a low level of corre-
fractal dimension from chaos theory. lation with each other is also suggested.
Railroad Track Charts: The Barron’s

The Use of Trading Bands Confidence Index
in Stock Selection . . . . . . . . . . . . . .13 Revisited . . . . . . . . . . . . . . . . . . . . . . . . . .29
Michael Baum Technical analysts often Bruce M. Kamich For many years the
use chart patterns to determine the trend of Confidence Index was a tool employed by
a stock and oscillators show if an item is over- technicians to analyze the stock market.
bought or oversold. Trading bands, however, The indicator has declined in popularity in
can provide the information at a single recent years, but Bruce Kamich has found
glance. Michael Baum shows how he inter- a new use for the Confidence Index by
prets the performance of a stock from its relating it to the movement of bond prices.
fluctuations within a trading range.

A Sealed Room and Membership and
Only One Client.. . . . . . . . . . . . . . . .35 Affiliate
Henry 0. Pruden, Ph.D. How many times Information. . . . . . . . . . . . . . . . . . . . . . . . .2
has news, fundamental information or for
that matter the everyday mundane demands
of the job distracted you at a critical juncture
of the market? John Magee felt the need for
a private place to help him focus on the
market without distractions. Hank Pruden Style Sheet for the
carries the concept a step further by provid-
Submission
ing some practical suggestions on how we can
assimilate our own objectives with our clients of Articles . . . . . . . . . . . . . . . . . . . . . . . . . . .3
objectives to provide the best possible service.
The Impact of Commodity

Prices on Bonds and MTA Officers and
Stocks: An Intermediate Committee
Term View . . . . . . . . . . . . . . . . . . . . . . . .39 Chairpersons. . . . . . . . . . . . . . . . . . . . . . .4
John J Murphy For many years techni-
cians were content to analyze markets in
isolation. In recent years, however, there has
been a greater tendency to use information
derived from other markets. John Murphy
has popularized the use of inter-market
Editor’s
analysis and shows the linkages between Commentary . . . . . . . . . . . . . . . . . . . . . . .7
stocks, bonds and commodities.
6 MTA JOURNAL/SPRING 1992

Editor’s Commentary
by James Bohan, Editor
The Journal has published an extra edition that you we lack knowledge or have a bias towards. Reviewing
will find enclosed with the regular edition of the Jour- manuscripts for the Journal, however, forces one to
nal. The extra is an index of all the articles published open up and consider all forms of analysis and
since January of 1978. Seminar editions issued in approaches. Working with authors to qualify papers
May were excluded. The index contains a summary can be arduous at times, but most often leads to a new
of each article sorted by subject. An author sort is also working relationship with a peer. An increase in
included. knowledge of the publication process is another
The MTA would like to thank Shelley Lebeck and benefit. Mike Moody will take over as editor this sum-
John Blasic for conceiving the idea for the index. mer. I am sure that Mike, who chaired the Library
John is also responsible for organizing the index by Committee the last two years and has been on the
author and subject and for summarizing the articles. Journal Committee, will find the task rewarding. I
The members should find the index useful in their will continue to handle the production end for Mike.
research. It could prove to be especially helpful for The MTA is changing due to a broadening of the
those preparing new articles for the Journal, espe- membership. An important part of the change is the
cially those writing CMT papers. CMT program that is an attempt to increase the level
Back copies of the old Journals are available in of professionalism by qualifying technical analysts.
limited supply and copies of individual articles are The CMT had been a two part process consisting of
available from the MTA. A form at the back of the two examinations. The Journal became involved in
index should help expedite orders. The charge is to the accreditation process because a paper could take
cover MTA costs. Members and afiliates may also the place of the second exam. All CMT candidates
borrow a back journal from the MTA library. who started the process in 1991 will have to take a
The flow of articles to the Journal has slowed of second exam and a Journal paper will be mandatory.
late. Members and affiliates are encouraged to sub- Writing a paper on a technical topic can be a worth-
mit their manuscripts for publication. Keep in mind while learning experience for the candidate and it
that CMT articles have more stringent requirements contributes to the base of research in the field.
than regular Journal articles in terms of content. (See In May fifty candidates started the certification
the CMT guidelines.) The index of past articles can process and forty candidates took the second exam.
be a source. Consider reviewing an old topic bringing In coming years, therefore, the number of papers sub-
it up to date and providing some new insights. mitted to the Journal will increase sharply. The flow
The recent survey of members conducted by Phil could become a burden on the Accreditation and Jour-
Erlanger, chairman of the Long Range Planning nal committees. Various solutions to handle the
Committee, showed that the members value the MTA increased workload are being discussed. The most
Journal. To improve the content, however, we need obvious solution will be to increase the size of the
wider participation. In addition to writing an article, committees. An alternative solution will be to grade
consider passing on your views on an article or on a the papers. Those who fail to pass will be able to
topic affecting the membership. Frequently letters to resubmit the paper after having made the recom-
the editor can provide additional insight on a topic. mended changes. The Journal would then be able to
select papers for editing and publication.
Passing the Baton
Editing the MTA Journal over the past two years This Issue’s Articles
has been a rewarding experience. I recommend it to The MTA awarded three CMT designations for
anyone who wants to broaden their exposure within contributions to the current Journal to Michael
technical analysis. There is a tendency to stick with Baum, John Murphy and Bruce Kamich. David Aron-
tools we are comfortable with and avoid areas where son’s article fulfills the CMT requirement, but he

must fulfill the requirements to become a regular
member before using the CMT designation. Tech-
nical analysis is becoming a fusion of different
techniques and the current issue of the Journal
provides a blending of new and old approaches. Dick
Orr supplies us with a new indicator derived from
his work on Chaos. David Aronson adds to the
literature on selecting and combining indicators.
Michael Baum provides us with his approach to
trading bands while John Murphy gives insight to
inter-market analysis. Hank Pruden shows the im-
pact of psychology and remaining focused.

Instability in the Stock Market
by Richard C. Orr, Ph.D.
Introduction of these extremes, for the eight days in question. In

One of the problems facing all market modelers is order to simplify terminology, volatility and in-
the lack of a controlled environment in which to stability are defined as follows:
experiment. If an event occurs, we can only guess
Volatility = Eight-day Moving Average of Daily Range.
at its precise impact on coincident market behavior.
The premise to be explored here is that there is an Instability = Eight-day RangeNolatility.
underlying structure to the market which deter-
mines to a large degree how it will absorb or fail to Instability as defined above is inversely related
absorb shocks. A classic situation is that of the Ken- to the approximate fractal dimension of an eight-day
nedy assassination on November 22, 1963. Clearly fractal thumbprint of the market, a concept dis-
the market had not “discounted” this event, yet cussed in a previous paper (see3). The actual calcula-
within a week this very strong market had complete- tion of the approximate fractal dimension can be
ly absorbed the tragedy and had resumed its long rather overwhelming (see l), but our instability
bull move. On the other hand, the market was so value serves the purpose quite nicely. The eight-day
unstable in early October 1987 that a moderate range is then just the product of its instability fac-
decline became a crash. tor and its volatility factor. As Table 1 clearly
In previous articles (see 2 and 3), I have argued demonstrates, larger ranges tend to have both larger
that there is a very subtle structure in the equity instability and volatility factors. If we look at the
market which is chaotic, in the scientific sense of the eight-day range by decile over the period 1984-91,
word. More recently, a new book by Edgar Peters (see both the average instability and volatility factors are
4) makes the same point from a different perspec- higher for each larger decile of eight-day range.
tive. The purpose of this paper is to demonstrate a
technique based on the concept of fractal dimension
from chaos theory, but involving only relatively sim- TABLE 1.
ple calculations, that provides us with a way to
measure the market’s tendency to trend or to move GEOMETRIC AVERAGES OF INSTABILITY
in a trading range. This process can also act as an AND VOLATILITY FACTORS FOR A GIVEN
DECILE OF &DAY RANGE (l/84-12/91)
early warning signal for the occurrence of explosive
moves in the market, either up or down.
- S-DAY AVERAGE AVERAGE AVERAGE
RANGE &DAY INSTABILITY VOLATILITY
Instability and Volatility as Components DECILE RANGE FACTOR FACTOR
of Range 1.790 2.423 0.739
In general, the range of prices refers to the entire : 2.363 2.748 0.861
3 2.659 2.886 0.922
set of values taken on over someperiod of time: hourly, 2.951 3.037 0.972
daily, weekly, et cetera. For our purposes, we will 2 3.261 3.297 0.989
6 3.633 3.456 1.052
define the range over somespecific time interval to be: 4.096 3.710 1.105
ii 4.688 3.908 1.200
9 5.529 3.995 1.383
(Percent) Range = lOO(High-Low)/((High+Low)/B). 10 0.232 4.096 2.006
In what follows we will show that the daily range

behavior for the past eight days affects the total
range of prices for the next eight days. Using the A Dramatic Change in the Market’s Stability
above definition, the eight-day range of a series of In January 1984, the underlying structure of the
prices is just 100 times the difference between the market changed. If one looks at a graph of the B-day
highest and lowest prices divided by the midpoint range values from 1979 to 1990 (see Figure I), the

change is almost imperceptible. However if one looks these two components nearly offset each other, their
at the two components of 8-day range, namely product which is the eight-day range did not show
volatility and stability over the same period (see the change. Instability may be thought of as the
Figures 2 and 3), the shift is more obvious. What tendency of prices to run in one direction, rather
becomes clear is that very early in 1984 the market than moving in a trading range. The more unstable
decreased in volatility and increased in instability. the market, the less a sequence of bars will tend to
Whether or not this was the effect of the serious use overlap each other on a bar chart. Since 1984, the
of index futures by institutions is a matter of con- market has tended to trend more, but with smaller
jecture, but the timing suggests it may be so. Since average daily ranges.
40
30 --
20 --
0 -I I I-+
l/79 l/84 l/90
FIGURE 1. EIGHT DAY RANGE
7 6.4
a.4
6
7.4
5 6.4
5.4
4
4.4
3 3.4
24
2
1.4
1 0.4
ln9 1184 rns 1184
FIGURE 2. INSTABILITV FIGURE 3. VOLATILITY

Instability as an Early Warning Signal Figure 4 shows the price action of the S&P 500
We now consider four specific examples of volatil- index during October 1987. Notice the extremely
ity and instability readings during market action of high instability readings even five days before the
the past five years. In each case, distributions of crash. By October 16th, volatility had also reached
volatility and instability values for the eight years an extreme. This was hardly the time to assume
prior to the year in question are used. This gives us that the bottom has been reached. After the crash,
a moving sample of approximately 2000 days. The the market continued to “ring”. It moved sharply
values of volatility and instability for the period up and down, indicating a return of stability, but
being studied are then ranked with respect to the volatility remained high for weeks. While not as
distribution of the sample. For example, if the current dramatic, the one-day plunge in October 1989 was
value for volatility exceeds any volatility value in the more insidious than the drop two years earlier, in
sample, it gets a percentile ranking of 100 for volatili- that it appeared to happen without warning. As
ty. If the current value for instability is smaller than Figure 5 shows, however, the extremely low volatili-
any instability value in the sample, it is ranked 0 for ty readings were matched by extremely high in-
instability. These readings tend to define market ac- stability readings, suggesting the potential for a
tion over the subsequent eight trading days, so high surprise. Volatility never did become higher than
readings signal the potential for unusually large about average (a reading of 50), and by the end of
moves, while small readings suggest the relatively the month the market had returned to a normal
quiet times over the next eight days. profile.
330.03- 3a5m-
J2o.WJ p ’ - ’ 1
310.00-- rlL?I[ 360.99-- $9, o
3m.09-_ IQ
290.00-. I0 35sm -- It c
280.00-- 3m.00-. t t
no.* -.
2uJ.m Qtt+ woo -mr 1 1 11 ’ t ‘1 1 I@
?YI.M--
24o.w -. -1 Ii t,ttI it , “Cr @ z” :I/ 1
zmca --
220.00-. 339.00-.
210.00--
2m.M- s%m-
PERCEHTILES PERCEMILES
CASE DATE 1NSTASMJT-V VOLATlLrrY CASE DATE INSTABILlTY VOLATlLlTY
: 12OCT97
16OCT97 98.9
96.7 90.1
40.9 : 6OCT89
aocT99 98.1
99.9 6.6
3 19OCT97 100.0 104.0 3 13OCT69 W.6 El
4 30 OCT 67 34.7 1W.O 4 26 OOT 99 6a.4 44.6
5 18 NOV 97 26.0 86.9
FIGURE 4. S&P 500 INDEX: 29 SEPT 1987 THRU 18 NOV 1987 FIGURE 5. S6P 500 INDEX: 22 SEPT 1989 THRU 26 DCT 1989
w Q)flr
@ ,tJ 39s.m -.
mm -. Yt tttt 39am -.
I
0 -3m.m -.
t bl$
3zQ.w -. qvpr I
31ma -. :: -.t t ’
300.00 - 370.00 -
PERCENTILES PEFlCENTlLES
CASE DATE INSTABILITY VOLATlUrr CASE DATE INSTABlLrPl VOLATILITY
1 9 JAN 91 90.8 70.5 : 19 DEC 91 69.1 13.4
: 21 JAN 91
31 95.4
94.1 73.9
39.5 3 14JAN92
23 DEC 91 94.1
2.5 30.9
47.9
4 22 FEE 91 0.8 70.2
FIGURE 6. SLIP 500 INDEX: 26 DEC 1990 THRU 22 FEE 1991 FIGURE 7. SIP 500 INDEX: 10 DEC 1991 THRU 14 JAN 1992

Figures 6 and 7 compare and contrast the market Summary
action in early 1991 and 1992, respectively. Notice We have split eight-day range into two com-
that, in each case, very high instability eventually ponents, volatility and instability, each of which
turned to very low instability, although the process helps us forecast the range for the subsequent eight
took much longer in 1991. In addition, the volatili- days. Volatility is the name we give to the eight-day
ty levels in 1991 portended a larger move than in moving average of daily range, while instability is
1992. then defined to be the eight-day range divided by
volatility. We have investigated their behavior, both
Forecasting Large Eight-Day Range Values. on macro basis and for specific memorable periods
Instability and volatility values for the past eight in recent market history. In addition, we have
days do have an effect on the range of prices for the demonstrated that high values of one or both of these
next eight days. If we restrict our attention to large measures tend to be good predictors of high future
eight-day range values, those of at least 8 percent, eight-day range values, while low values of both of
we find that current low volatility and instability these measures suggest the absence of these high
values imply that no large moves will occur within eight-day range values. For this reason, instability
the next eight days, while high volatility and in- and volatility seem to be very useful measures for
stability values imply a disproportionately high monitoring the likelihood of a dramatic move in the
incidence of large moves within that same period. market.
Table 2 shows the distribution of the 75 cases in the
2022 days from 1984 through 1991 in which the
eight-day range was at least 8 percent. Note that in
BIBLIOGRAPHY
the vast majority of cases either the instability or
1. Mandelbrot, Benoit, The Fractul Geometry ofNature (Freeman,
volatility readings for the day just prior to the begin- 1983)
ning of the eight days in question fall into the fourth 2. Orr, Richard C., “Chaos I: Time Series Forecasts in Markets”,
or fifth quintiles. In no case do the instability and MTA Journal 33 (1989)
3. Orr, Richard C., “Chaos II: The Fractal Structure of Markets”,
volatility readings both fall into the first or second MTA Journal 35 (1990)
quintiles. This result is actually even stronger than 4. Peters, Edgar, Chaos and Order in the Capital Markets (John
it appears, since in all nine cases where neither in- Wiley, 1991)
stability or volatility is in the fourth or fifth quin-

tiles, a subsequent day reaches these levels before
the 8 percent move begins. The bottom line is that DI: Orr is president of Chronos Carp, a firm specializing
high instability or volatility readings give a warn- in Chaos related research for financial markets. In ad-
dition to actively trading Stock Index Futures, he is a
ing that the market is vulnerable to a “shock”, while frequent contributor to the MTA Journal.
low readings in both variables sound an all clear
signal.
TABLE 2.
COUNTS OF FUTURE 8-DAY RANGES OF AT
LEAST 8 PERCENT CORRESPONDING TO
CURRENT INSTABILITY AND VOLATILITY
READINGS BY QUINTILE (l/84-12/91)
INSTABILITY
QUINTILES
TN 3
I T

Railroad Track Charts
by Michael Baum
Overview must constantly shift his or her attention between

Sharp movements of common stocks well above or these charts.
below their trading ranges often provide excellent The Percentage Trading Bands are a set of
opportunities for profit. This occurs since most near parallel trendlines at a fixed percent above and
term price moves have proven to be unsustainable below a particular moving average. Most technical
and are usually followed by a counter-move that analysts draw their parallel lines, delete the moving
restores the prior period’s price equilibrium. As a average used in the chart’s construction and then
result of this observed phenomenon, an extensive list superimpose a closing price of the particular market
of indicators has been developed by market practi- under study. (See Chart B) This important innova-
tioners. A listing of some of these popular momen- tion was developed by Ichu Cheng3 who integrated
turn oscillators appears below. A variation on this the separate price and oscillator charts into one. He
work is spelled out in detail in this monograph. A suggested an actual price cross above or below the
caveat to consider, however, is that the over-bought/ trading bands themselves could well generate
over-sold approach to timing does not fit under all suitable entry and exit signals. Ichu Cheng made the
circumstances. A particular stock or market index small, but all-important step, of integrating the price
may remain in an over-extended position for a very and oscillator charts to create one all-inclusive indi-
long period of time. This usually occurs when a cator. The oscillator featured here is based to a large
powerful long term bullish or bearish wave of inves- extent on the original work of Ichu Cheng. To
tor psychology over-rides the more typical pattern differentiate this approach from the general scholar-
of an individual market’s ebb and flow. Examples of ship on momentum oscillators, the indicator dis-
this tendency will be explored in the article. cussed below will be referred to simply as “Railroad
Track Charts.”
Definitions
An oscillator is. . . “Any mathematically calcu-
CHARTA
lated line, or lines, that move up and down with
price activity in such a way that over-bought and
over-sold situations can be identified. (They). . . are
often at their extremes at tops and bottoms, and 44
visually illustrate the swings of the market from
over-bought to over-sold. . . .“I See Chart A. Over
the years, an extensive list of oscillators has been
developed and fine-tuned by market technicians. CHARTB
Most are now available in chart programs for per-

sonal computers. For example, the Dow Jones
Market Analyzer PLUS chart program carries a $
variety of indicators such as Stochastics, Wells-
Wilder’s Relative Strength, Williams’s %R, Moving
Average Convergence-Divergence, Commodity Chan- CHARTC
IDEALIZED
nel Index and Percentage Trading Bands? Most
BREAKDCWN
oscillator charts are presented by showing an indi- BREAKOUT
vidual issue or market index and its momentum
oscillator on the same computer screen. Two sepa-
rate charts are constructed on the same monitor.
To obtain market entry and exit signals an analyst

Gerald Appel also demonstrated the judicious use overcomes supply thus enticing some longs to
of Percentage Trading Bands as a market forecasting postpone their selling in the hopes of additional
tool before his colleagues at a regular Market Tech- gains. As a consequence, selling volume diminishes
nician’s Meeting in New York City? Christopher and and exaggerates the advance until it is carried to an
Peter Worden have cleverly fashioned a succession up-side extreme. Once demand is exhausted, a
of trading bands one and two standard deviations counter-move follows. The selling that was deferred
from the moving average itself? John A. Bollinger during the prior rise comes to market, creating a
more recently added trading bands that expand and selling wave that drives the market lower. This
contract a pre-set number of standard deviations decline is intensified as some potential buyers defer
above and below a moving average.6 All of these their purchases. As a result, buying volume dries up
analysts have contributed valuable innovations to accelerating the speed and force of the down trend.
the design of the Percentage Trading Band indicator Only after sell-side pressures carry the market to an
work. extreme, and selling volume finally diminishes, does
bargain hunting slowly emerge and the market
Mechanical, Emotional and Psychological begins to stabilize. At this stage, the market is posi-
Rationales for Periodic Market Fluctuations tioned to begin its’ complete price cycle again.
Around an Arithmetic Mean The late Michael G. Zahorchak suggested an
William C. Garrett provided a mechanical emotionally-based positive feed-back loop to explain
rationale for market fluctuations around a mean.7 periodic price cycles that yield over- bought and over-
He suggested that the forces of supply and demand sold conditions.8 Here is a brief synopsis of his
are constantly struggling for superiority. For exam- explanation. After an uptrend begins, sideline
ple, following a period of price equilibrium, demand money flows into the market driving it higher. As
CHART VERSION 2.1 CHART VERSION 4.1
CHARTVERSION 1.5 CHART VERSION 3.5 CHARTVERSION 4.5

CHARTVERSION 2.5
CHARTVERSION 4.6
CHART VERSION 4 9
RIGHTTRANSLATION BULGE

the market becomes stronger, it continues to attract expect future surprises to force prices toward their
fresh funds. Motivation to rush in and buy a strong mean more often than not.” Cootner referred to these
market stems from the emotional pressure within springboards for a move back towards their mean as
individual investors. As investment observers gain “Reflective Barriers”. (Many chartists refer to these
confidence from rising prices, a point is reached barriers as support and resistance). Martin E. Zweig
where some investors yield to greed. took Cootner’s model an important step further? He
When all the capital available for investment has incorporated the “Reflective Barrier” model in terms
been drawn aboard the market, demand tires and of a general theory of investor expectations. “When-
prices turn down. Sagging prices then activate a ever non-professional investors become significantly
bearish feedback loop within the personality of one-sided in their expectations about the future
investors. Lower prices build the pressures to sell. course of stock prices, the market will move in the
As investors reach the point where they can no direction opposite to that which is anticipated by the
longer tolerate the stress of holding a deteriorating masses.”
stock position, they close out their long positions.
Finally, a sellhng climax occurs under the pressure A Cyclic Framework for Railroad Track Charts:
of panic liquidations and a bottom is completed. The The Earnings Report Cycle
positive feed-back loop begins anew to push the Assuming the cyclic character of stock prices and
market to its next peak. the transient character of market extremes, the first
Paul H. Cootner introduced a model of market task is to find the most suitable time frame for the
behavior in 1962.9 “. . . Professionals . . . profit. . . moving average used to construct Railroad Tract
from observing the random walk of the stock market Charts. Many timers refer to price cycles of three to
prices produced by . . . (the) . . . non-professionals six months as the intermediate-term rhythm. It has
until the price wanders sufficiently far from the been observed that many stocks and stock groups
expected price to warrant the prospect of an ade- have price cycles of different periods. Furthermore,
quate return . . . When prices have deviated enough some issues peak and trough ahead of the average
from the expected price . . . (professionals) . . . can issue, others score their highs and lows in harmony
CHART D
OVER-EXTENDED CONDITION
AFTER A LONG RALLY
80- OVER-EXTENDED CONDITION -80

AFTER A CORRECTION
WEEKLY DATA
DISNEY (WALT)
60- -60
4% TRACKS PROJECTED
- ‘I’ FROM A 13 WEEK
I I
I I
MOVING AVERAGE
I I
1948’7 88 89 90 91 7% 1

with the average stock while some issues record their follows initiates the up phase of the next cycle.
peaks and valleys later.
The problem of cycle identification is further Idealized Model of the Intermim Earnings
obscured because some price cycles of three to six Cycle (Chart 0
months are distorted or overwhelmed by cyclic forces. Starting from a period of price decline with the
For example, an intermediate term uptrend may be tracks in a down mode, the first price cross above the
dampened by the bearish influence of a long term lower track is referred to as an Initial Rally Signal,
down wave. In addition, some price cycles have a (See Chart Version 1.0). This event marks the first
tendency to vary widely and then return. Perhaps evidence that selling dominance is beginning to
the most difficult roadblock to cycle identification exhaust itself and a market is moving toward equi-
is double-counting. In this instance, a stock may bot- librium or possibly a new interim cycle of advance.
tom, rally, peak and react within a six week period. Usually an up-side cross is followed immediately by
Then the stock repeats the round trip in seven weeks a Basing Phase or trading range inside the tracks
leaving two cycles. When this occurs, the chartist as the last of the selling by disappointed longs comes
must decide if the issue is running a shortened inter- to market. In this pattern, the tracks themselves
mediate term cycle, or two near term cycles that mark-off the extremes of price fluctuation. They are
make up one thirteen week movement. the “Reflective Barriers” discussed by Cootner and
Recognizing the difficulties involved, the iden- Zweig. In rare cases, the Basing Phase may be
tification of the intermediate term cycle could well characterized by a succession of up-side and down-
be considered within the reporting framework of cor- side violations followed swiftly by counter-moves
porate earnings which averages 13 weeks or 63 days. back inside the tracks (See Chart Version 1.5). In this
Actual reporting of income figures depends upon the erratic pattern, the forces of supply and demand are
accounting cycle for each firm. As a result, most continually shifting their dominance.
interim figures are released three to six weeks after An Up Phase is illustrated on Chart Version 2.0. .
the end of the quarter. First quarter data appears It is marked by a market cross-over the upper track.
from mid- April on, second quarter data begins This event is called an Initial Breakout Signal.
appearing in mid-July and third quarter results are When this occurs buying dominates the market and
distributed beginning in mid-October. Firms with prices move swiftly above their upper track and may
different fiscal periods report their earnings from remain overextended. The Up Phase suggests that
three to six weeks after the end ‘of their fiscal an opportunity to enter the market has already pass-
quarter. Year-end figures are usually delayed ed, and that existing positions should be maintain-
because of full year adjustments and full year num- ed. In this phase, market prices may rise swiftly and
bers may take four to eight weeks or more before create a pattern referred to as a “Left Translation
release. This stretch-out in reporting could well Bulge” (see Chart Version 2.1). This configuration
account for 73.56 days calculation for the complete suggests an absence of supply combined with aggres-
intermediate term cycle of the Standard and Poor’s sive demand. In cyclic terms the pattern suggests the
300 Index.” To fit within the reporting cycle, this bullish influence of longer term waves upon the
monograph has selected the 63 day or thirteen week interim price cycle. Version 2.5 is marked by a suc-
time period for determining cycles, but allowance is cession of cross-overs and cross-unders while the
made for a longer cycle at year end. track itself has an upward slope. In this instance, the
track itself is playing the part of a center-line for a
,
rhe Discounting Process series of short term cycles. The investment strategy
As a general rule the market begins to discount in this case is to hold all positions as the most ideal
i interim earnings figures a month or so before the time to enter the market was seen at an earlier
1release date. A stock usually moves higher in antici- phase. Chart Version 2.6 reveals an erratic market
1 pation of favorable news. If results meet the expecta- pattern. This volatile pattern provides numerous
1Lions of a majority of market practitioners, a peak short-term trading opportunities each time the
iin the price cycle is soon evident. The profit-taking market registers a cross-over or cross-under. Under-
1;hat usually follows generates an interim earnings lying the succession of these sharp movements is a
(cycle trough. The situation is reversed when poor conflict between the bullish influence of the Up
t:arnings are anticipated. Prior to the announce- Phase of the interim earnings cycle and the more
1ment, the stock is often subject to selling pressure bearish pressures of a longer term wave. Chart
‘ Ind price weakness. Some further liquidation is Version 2.9 is referred to as a “Right Translation
1 possible after the release of earnings, but selling Bulge.” It is a climactic buying surge after an over-
1Jsually ends quickly, often marking an intermediate extended rise fueled by short covering.
1;erm cycle trough. The bargain hunting phase that Selling opportunities often occur with the official

release of earnings or other pertinent news items. track so the lower track marks overhead resistance.
A Topping Phase usually follows (See Chart Version This configuration is the mirror image of the Up
3.0). It is ushered in with a market’s down-side cross Phase (Version 2.0) where the upper track provided
below an upper track. This event is referred to as an support for every short-term cycle trough. If the
“Initial Reaction Signal.” In this case the market’s Chart Version 3.0 Topping Phase Initial Reaction
short term fluctuations are contained inside the Signal was missed, the Initial Breakdown Signal in
tracks as a narrow trading range unfolds. Wider Chart Version 4.0 provides another opportunity to
short term cycle swings within this phase are lighten positions or exit the market. During the
depicted by Chart Version 3.5. Every upside cross- Down Phase, new buying is best deferred until sell-
over above the lower track is a trading buy signal- ing is exhausted. Following the initial breakdown,
while each down-side cross below the upper track is a sharp decline may occur. It is referred to as a Left
a reaction or trading sell signal. This configuration Translation Bulge (see Chart Version 4.1), and
and the one portrayed in the Basing Phase (version reveals the sellers are dominant. When the lower
1.5) represent a balancing between the longer term track bisects the short term cycles a Chart Version
forces of supply and demand. This provides an 4.5 is seen. A timer could well look to the slope of
environment for the weak but intense short term the lower track for help in assessing if this phase
cycle influences to show themselves. If the balance is still in force or finally giving way to a more bullish
of bullish and bearish forces are finally resolved on Basing Pattern. Here again, the chartist is caution-
the down-side, the Topping Phase soon gives way to ed not to anticipate a bottoming pattern, but wait
a Down Phase (See Chart Version 4.0). First evidence for the signals to show themselves.
of this final phase in the Interim Earnings Cycle is On occasion one may come upon a wildly erratic
a market cross-under of the lower track that is itself behavior pattern as seen in Version 4.6. In this con-
beginning to turn down. This indicator event is dition, short term cycles penetrate the upper and
called an “Initial Breakdown Signal.” It is often lower tracks providing trading opportunities within
followed by a free fall in the price of the stock. All a basically down market. Risks are higher under this
short term rally peaks are contained below the lower condition when trading the long side because the
CHART E
OVER-EXTENDED CONDITION AFTER
A LONG RALLY
95-
85-
-65
AFTER A LONG CORRECTION
WEEKLY DATA -55

MINNESOTA MINING
4% TRACKS PROJECTED

short-term-up-leg may be suppressed by the stronger normal rhythmic pattern. During the year-long rise,
interim earnings wave. If a stock or index crosses Disney shares remained in an over- bought condi-
above a lower track, flashes a Rally Signal, and tion. Reactions below the upper track proved tem-
immediately reverses by crossing below the lower porary. The overbought periods may have prompted
track again, the prior breakdown signal has been caution, but the fact that the lower band was not
restored. A down market is evidently still in force. penetrated during this period should have kept the
Trading strategy suggests quickly closing positions. analyst constructive. By late 1990 a more rhythmic
The final and most devastating pattern for most pattern was initiated by penetration of the four
investors is seen in Chart Version 4.9. It is called a percent.
“Right Translation Bulge” and usually appears as Chart E, Minnesota Mining, provides a more
a climatic selling wave at the end of a Down Phase. typical example for railroad track identification. In
The anatomy of Chart Version 4.9 is as follows: Sell- this example, four percent tracks calculated from a
ing begins to dominate in the 4.0 condition. As a thirteen week moving average are shown with the
decline proceeds, the ranks of bargain hunters weekly bar chart. Every over-extended condition in
become thinner until buying dries up. As a conse- this four year period proved unsustainable and was
quence, sellers overwhelm the internal balance of the followed by a counter-move back inside the tracks.
market and liquidate at distressed price levels. This The Standard & Poor’s 500, with two percent
creates the Right Translation Bulge, and sets the tracks based on a thirteen week moving average, is
stage for a counter-move that begins the Basing shown in Chart (Fj. This example provides a com-
Phase, Chart Version 1.0 and the new Interim Earn- bination of conditions found in Charts D and E. For
ings Cycle. example, in 1988, the index failed to break down
Normally the cycle runs from chart 1.0 through below the lower two percent tracks. The performance
4.9 and then starts anew. The timer should be aware shows the growing bullish influence of a long term
that the sequence may skip. In a bull market, the wave. By 1989 these positive forces lead to a S&P
charts may run 1.0, 1.5,2.0,3.0 and then start over Index rally of 35%. The first penetration of the lower
again at 2.0. In retrospect, it can be seen that 3.0 channel in late 1989 indicated that the advance was
is a congestion period or narrow trading range prior exhausted and equilibrium was restored. To simplify
to the resumption of the bull cycle. The opposite is the graphing, a chartist might find the weekly close
the case in a bear market. A stock may end a 4.0 easier to work with. In summary, two percent tracks
Down Phase, generate an Initial Rally Signal, have been found useful for the Dow Jones Industrial
display a Basing Phase only to quickly roll over and Average and Standard and Poor’s 500. The weekly
flash an Initial Breakdown Signal. In this case, the advance- decline line and most blue chip issues work
normal sequence was disrupted because the selling best with four percent tracks. In a study of about
pressure from the bear market suppressed the Up three dozen issues including many Dow Jones In-
Phase, overwhelmed the buy-side of the market and dustrial issues, several exceptions have been found.
pushed the cycle from 4.0 to 1.0 and immediately Included in this class special category are Eastman
into a 4.0 phase once again. Allowance should be Kodak, Mobil and Procter & Gamble. Here, three
made for the possibility of a back step to an earlier percent bands match up quite well. Listed secon-
phase once evidence of such a pattern appears. daries have been found to chart best with eight
percent tracks. No exceptions have been found in this
Railroad Track Chart Construction: lower price group after study of about four dozen
Real Life Examples issues. Finally, a daily advance-decline line also
Parameters are set from a review of past chart works well with the eight percent parameters.
history. Chart (0) shows weekly data covering a three Experimentation is needed to determine the best
to four year cycle in the common stock of Walt Disney. parameters for a particular market.
Four percent tracks above and below a thirteen week
moving average were drawn and a high-low-close Technical, Fundamental and Psychological
chart was superimposed. This example illustrates Aids in Pinpointing an Intermim
some of the problems that must be overcome to find Earnings Cycle
the most ideal parameters to measure over-bought This monograph covers in detail the technical
and over-sold conditions. In early 1988, Disney aspects of the Interim Earnings Cycle. The charts
shares broke down below its lower track on a few are a pictorial model (or representation) of where the
occasions. The issue subsequently snapped back stock has been and where it is positioned to go.
towards equilibrium, and in early 1989 the issue Knowledge of the accounting cycle and the release
took off on a long bull market surge. A positive long dates for earnings is also required. Those are
term wave of investor psychology over-rode the available in the Daily Graphs Chart Service?’ This

valuable listing reads EPS due, meaning the date to the market’s response. To a lesser extent, cor-
when Earnings Per Share were released in the prior porate news on backlog figures, contract awards,
year. The assumption is made that the latest release management changes or feature articles in the
will come on or around that date. media are valuable psychological clues. It is indeed
The Value Line Publishing Inc provides an excel- the market’s behavior following these various media
lent forecasting service of upcoming sales and earn- events that exposes the underlying supply-demand
ings figures.‘3 Many of the posted figures for interim condition and where the stock or market stands in
figures come out close to or precisely at the Value its cycle.
Line estimates. This excellent showing suggests the
service comes up with their own figures but may well Benefits to the Railroad Track Chart Approach
obtain some confirmation from the reporting com- Since stocks and the market spend most of their
pany prior to the release date. On occasion, reported time meandering inside their tracks, the Railroad
figures are far from the estimates issued by Value Track Chart Work frees the timer to focus upon an
Line and other analysts. The market had usually an- issue when it is at an unsustainable extreme. As a
ticipated this development and discounted it in the result, the analyst may be more alert to the signifi-
market price before the news release date. When the cance of a cross-over or cross- under and the poten-
interim figures are surprising to a majority of tials of such a signal. This approach also insulates
market practitioners, the market swiftly adjusts on the timer from the emotions in the market place and
or immediately following the news release date. A the media helping one to become psychologically
third aspect of this Interim Earnings Cycle is attuned to the possibilities of a stock or market’s
psychological. If the news is widely expected it will counter-move. Independence of thought, analytical
not upset the delicate supply-demand balance in the focus and sensitivity to rapidly changing price con-
market place. Conversely, If the news is not antici- ditions should not be underestimated. Furthermore,
pated, a dramatic move could follow. As a result, the the cross-overs and cross-unders provide actual intra-
true technical position of that market is suddenly day market entry and exit signals. When the initial
revealed. It is necessary for the timer to quickly shift signal is followed by a succession of signals, it pro-
from the fundamental aspects of the earnings release vides a valuable prompt to slowly accumulating
CHART F
AFTER A RALLY
380 -
340 -
OVER-EXTENDED CONDITION -
AFTER A CORRECTION
-260
WEEKLY DATA-S&P 500
2% TRACKS PROJECTED FROM -
A 13 WEEK MOVING AVERAGE

stock in a Basing Phase or distributing stock dur- of this timing approach. Still, the Railroad Track
ing a Topping Phase. approach highlights important changes in a
Divergence analysis is also possible. The market market’s behavior. It spotlights those rare occasions
being measured may make a succession of lower when a market is at an historic extreme. This in turn
price lows, but the lower track itself may well be fall- opens the door to a profit opportunity. After all, what
ing at a faster rate. It is “catching up ” to prices. As better moment is there to buy any stock or index
a consequence, the gap between lower tract and the than after an episode of selling finally spends itself
market narrows. This pattern reveals a loss of and the issue lifts its head enough to cross above a
downside momentum and a non-conformation is fast closing lower track? Conversely, after a long rise
recorded. On occasion these signals are generated what better time can be found for profit-taking or
quite close to the actual peaks and valleys. lightening up of positions than the instant a market
Since moving averages are the heart of the falls below a fast rising upper track for the very first
Railroad Track Chart construction process, the time?
Interim Earnings Cycle may be fit inside longer and
longer moving averages to gain a summing of all the
dominant waves impacting any market. Such a big
picture analysis is a topic which might be investi-
REFERENCES
gated before a Railroad Track analysis is attempted.
1. Walter Bressert, “The Power of Oscillator/Cycle Combinations”,
Walter Bressert and Associates (Tucson, AZ) 1991 p. 3-1
Limitsoto the Railroad Tract Chart Approach 2. “Dow Jones Market Analyzer PLUS” Version 2.03, RTR Soft-
Without question, the major limitation to this ware, Inc. and Dow Jones & Company, Inc (Princeton, N. J.) 1991
3. Ichu Cheng, Holt-Winter Channel: Taking the formula one step
work is the potential for false signals or whipsaws.
beyond, “Technical Analysis of Stocks and Commodities”,
To compensate for this limitation, the chartist is Technical Analysis, Inc. (Seattle, Wa.) August 1988, p.23-28
invited to look at the Railroad Tracks within a cyclic 4. Gerald Appel,“Timing the Market with Moving Averages and
Trading Bands”, Signaler-t Corp. (Great Neck, N.Y..) March 12,1966
framework. Being cognizant of earnings estimates,
5. Christopher and Peter Worden, “Optioneer”, Worden Brothers,
the release dates of interim figures and the sensi- Inc., (Chapel Hill, N.C.) 1991
tivity of the market to the release of data should be 6. John A. Bollinger, Financial News Network, (Los Angeles, Ca.)
7. William C. Garrett, “Investing for Profit with Torque Analysis
an aid in interpretation. of Stock Market Cycles”, Prentice-Hall, Inc., (Englewood Cliffs,
At least two exceptions will be encountered by N.J.) 1973, p. 25-28
an analyst running Railroad Track Charts. First, if 8. Michael G. Zahorchak, “The Art of Low Risk Investing”, Sec-
ond Edition, Van Nostrand Reinhold Company (New York, N.Y.)
a market replicates Chart Version 2.5 or 4.5 the 1977, p. 25-30
track being crossed and recrossed is really a mid- 9. Paul H. Cootner, Stock Prices: Random Vs. Systematic Changes,
point for short term fluctuation. Reliable entry and “Industrial Management Review”, Volume III, Spring 1962,
p.24-45
exit signals can not be obtained. In this instance, we
10. Martin E. Zweig, Investor Expectations: Why they are the key
would suggest trying new parameters. On another to stock market trends, Zweig Advisors, (New York, N.Y.) 1973
occasion, a timer may find a market low three or four 11. Cycle Projections, Foundation for the Study of Cycles, Inc.
points below a lower track. The issue may then (Irvine, Ca.1 Aug. 1990, p.1
12. Daily Graphs, William O’Neill & Co, Inc. (Los Angeles, Ca.)
rally slightly above an upper track, give a buy 13. Value Line Publishing Inc, 711 Third Ave, (New York, N.Y.)
signal, and immediately reverse and give a sell and
drop three or four points again. Here too the
parameters have been incorrectly cast. The lower
Michael Baum is a broker and analyst with Hampshire
track should have been drawn perhaps five or six Securities Corp., 919 Third Ave, New York, N.Y 10022.
percent below its centered moving average. He also teaches a market timing course in a computer
In addition to the earnings cycle, Bond and com- lab setting at New York University School of Continu-
modity cycles of different length may well effect par-
ticular common stocks. Examples include oil and
natural gas issues as well as some credit-sensitve
issues. This secondary impact could well distort the
effected markets being run on the thirteen week
time frame.
Discussion
The integration of line charts and oscillators into
one composite indicator can not provide a perfect
solution to investing and trading. None is implied.
Periodic whipsaw signals and trading losses are part

Moving-Window Correlation Stability and
Its Use in Indicator Evaluation
by David Aronson
Introduction practical use. Consider an indicator which has a

As the discipline of market analysis becomes more significantly positive CC of +.50 when measured
quantitative there is a growing interest in objective over an entire twenty year period, but when mea-
ways to measure the predictive power of an indicator. sured over one year sub-periods its value is so
One way would be to calculate the linear correlation variable that its sign occasionally reverses to nega-
coefficient (CC) between the indicator and subse- tive. During such sign reversals the indicator pro-
quent market changes! In general CC is used to vides false predictions. For example, high indicator
measure the strength of the linear relationship (i.e., readings, which should be followed by rising prices,
dependence) between two variables, a predictor vari- as implied by the positive full span CC, would in fact
able and a dependent variable. In the case of indi- be followed by a falling market. High CC instability
cator evaluation, the indicator serves as the predictor renders an indicator far less useful than another
variable while the market’s subsequent change plays whose average CC over the full span is lower, but
the role of dependent variable. For example, the more stable. Our thesis is that CC stability is an
dependent variable might be defined as the percent- important characteristic that should be incorporated
age change experienced by the market over the into indicator evaluation. We propose a method for
month following a given indicator reading. To the measuring and using CC stability.
extent that their relationship is linear, CC measures Our method measures CC stability by employ-
how well the indicator is able to predict the market’s ing a moving data window. The concept of a moving
future change. data window is common in time series analysis and
CC can assume any value from a maximum is used, for example, when constructing moving
value of + 1.0, indicating a perfect positive relation- averages. In contrast to a typical full span CC, the
ship between the two variables, to minimum value moving window correlation coefficient (MW-CC)
of - 1.0, indicating a perfect negative relationship. computes the CC value only for those observations
A negative relationship implies that high indicator contained in the data window, whose length, N, is
readings forecast a bearish market. If the two vari- defined by the analyst? After each calculation, the
ables are plotted against each other in a scatter window is moved forward in time by one observation,
diagram, a perfect linear relationship is indicated and the CC is recalculated. The MW-CC operation
when all observations lie on a straight line. Magni- produces a fluctuating time series that itself can be
tude is the important quantity when measuring measured in terms of its average, its standard devia-
predictive power so indicators displaying either tion and its trend. The standard deviation gives an
significantly positive or negative CC values would indication of the stability of CC. The average and
be useful predictors. CC values close to zero indicate standard deviation are combined into a ratio which
no linear relationship. The minimum CC required I have named SACC (Stability Adjusted Correlation
to evidence a statistically significant relationship Coefficient). Our thesis is that SACC is an infor-
depends upon the number of historical observations mative measure that adds a useful new dimension
used in its calculation and the level of confidence to indicator correlation analysis.
desired by the analyst?
Prior indicator research has focused on measur- The Correlation Coefficient:
ing CC over entire spans of historical data? For An Intuitive Explanation
example, given twenty years of weekly observations, The statistical theory behind the CC can be
the CC would be calculated for the full twenty years. found in any basic statistics book. It is not our pur-
However, such studies have ignored the stability of pose to review that material, however, for readers not
the CC over shorter time intervals. Clearly, stability familiar with the concept, a brief description and
is an important property, if the indicator is to be of some diagrams will provide an intuitive notion of its

basis. Readers already familiar with this material What is a “Significant” Correlation
may wish to skip to the next section. Since even the best market indicators carry scant
Suppose we have a set of historical data based amounts of predictive information, they don’t pro-
upon two variables. One variable is an indicator duce tight cigar-like patterns such as “b” or “e”, but
whose predictive power we wish to determine, while rather scatter plots that resemble “loose” rotund
the second variable is a measure of the market’s ovals such as “c” and “d”. These typical point clouds
future return. Imagine plotting this data on a 2-di- are often hard to distinguish visually from round
mensional plane, usually called a scatter plot. On point clouds ( e.g. “g”) which are produced by indi-
the plane are two mutually perpendicular axes. By caters with little or no value (i.e., CC = 0). Therefore
convention, we assign the market’s future return to we need an objective way to distinguish indicators
the vertical axis, while the indicator’s values are with and without statistically significant forecasting
assigned to the horizontal axis. The location of each information from those lacking it. This can be accom-
point on the plane represents the values of the two plished by applying a statistical test to determine
variables at a particular point in time. Depending if the magnitude of the CC is significantly different
on the strength and nature of the relationship we from zero. The logic for interpreting the significance
get a “cloud” of points that will resemble, to some test of CC is as follows. We start off with the
degree, one of the seven diagrams below. hypothesis that the indicator has no forecasting
DIAGRAM 1
l t
. .
.
9.
.
. l . .
-- . . mm..
.~ . 9.m. l 0’
. ‘9 . . .
. ..
C::!‘:!=:::::!C *;;;;.; ?f;;.:+
.- ‘9’ .
. . ..=.. -.= l
l 9. 0’~.
. .*.
.
. ~- mm
l .’ ..= . ‘9. . l. ’
. .=:. l mm.. .
.. ((=+I.0 ((=tJl . l l
. . K=+.2S
t f
(0) Perfect Positive (b) Strong Positive (c) Weak Positive
.
.~.’ .
9’ mu mm l
l
.. lm:.’ .
...‘.
’ l
l
” i. l ‘0 ‘-~.I
. mm ..‘..
rn’. ” *
l . .
. ’ urn’. ’ l
.
. .
. . ‘m
vedicol oxis is fufure ma&t return
l . K=O
horizontal axis is indicator value
t
(g) No Relationship
. . .
.
l mm. mm l .
l
.
. .
.
l *. l .= 9.‘.
. .‘.. .
mm. l . 0 .
...m..-*m . l . ‘rn~ .
l . . .
. l 9.0~‘. .
4 : :
0..
6.l J’...,‘.
? I,:!:::‘!!:
.. ::c
.’ l m* . l. . l .m
.’ ’ ’
.
mm . ... . .= . . ...= .
l . mm.= .
...I:mmm : ’ l l ’ l .
8 l . .
. l .
mm. l . K--LO
(d) Weak Negative

t l&-.25 (e) Strong Negative
h-.70
(1) Perfect Negative

value (i.e., that the CC=O). This is known as the null techniques, such as non-linear pattern recognition
hypothesis. Statistical inference proceeds on the and multi-layer neural networks can.5 These ad-
basis that if you can reject the null hypothesis you vanced methods are beyond the scope of this article.
are entitled to believe its opposite, (i.e., that the
indicator has some predictive value). The burden of Moving Window Correlation Coefficient
proof is on the indicator to show it has forecasting & SACC
information. Our approach to measuring CC stability is the
The significance test tells us how confident we MW-CC which employs a moving data window. The
can be that CC, does not equal zero. The test, which window length is a parameter specified by the
takes into account the number of data points used, analyst. MW-CC computes CC only for the data con-
is based on the statistical principle that many re- tained in the data window. After each computation,
peated measurements of the CC between two uncor- the data window is moved forward by one time
related variables, produces a normal distribution. period and CC is recomputed.
Moreover, the standard deviation of this distribution In this study the data window length was
is equal to: l/square root of the number of data specified as 208 weeks, or approximately four years.
points. The area bounded by one standard deviation There is nothing magical about this window length
above and below the mean is equal to 68% of the area and it was chosen simply because it corresponds
under the entire distribution. For example with 200 roughly to a major cyclic period in stock market fluc-
data points the CC has a standard deviation of 0.071. tuations. We could have just as easily used 100 or
This means that even if two variables are unrelated 50 weeks. Because of the window’s 208 week length,
and their true CC=O, there is a 68% chance that the four years of past weekly data were required to
CC will take on a value between -.071 and +.071. generate the first MW-CC value. For example, to
The region enclosed between -2 and +2 standard produce an MW-CC value for the first week of
deviations (i.e., between CC values of -.142 and January, 1965, data back to January 1961 was re-
+.142) is 95% of the area under the normal distribu- quired. Moreover, the value computed for January
tion. Therefore, CC values can occur within this 1965 would not have been knowable until some later
range with a 95% probability even if the true CC=O. date, when the value of the market’s future change
Continuing this logic, if an indicator has a CC value became known. In this study the future return
greater than +.142 or less than -.142, which will variable required one year of future data. Thus the
occur by chance only 5% of the time when the true MW-CC for January 1965 would not have been
CC=0 we can be 95% confident that CC does not knowable until January 1966 even though on our
equal zero and the indicator has some forecasting plots the value is posted as of January 1965. This
value. CC values beyond +3 or -3 standard devia- is simply a convention we have adopted for this
tions give us confidence that our indicator has some study and there is nothing sacrosanct about this
value with 99.7%. Below we give some key values choice. This explains why our plots end on 6/30/89
whichCC must exceed to be significant at the 95% even though our available data extended through
and 99% levels of confidence. 6/30/90. Also, to reduce computation, the data win-
dow was moved forward by 13 weeks instead of one
week each time a new MW-CC value was computed.
Number Data Points
# weeks/years CC magnitude for 99.7% Our indicator figure of merit is derived from the
of data 95% Signif Signif statistical characteristics of the time series gen-
erated by the MW-CC technique. Specifically we
104 2 yrs .20 .30
measure its average value and its standard devia-
208 4 yrs .14 .21
tion over a period 24.5 years. From these two
520 10 yrs .09 .13
statistics we created a ratio that called the SACC
1040 20 yrs .062 .093 (Stability Adjusted Correlation Coefficient) using
1300 25 yrs .055 .083 the following formula: (note the vertical lines indi-
cate the absolute value of the ratio is used).
As pointed out above, this article is confined to
SACC= IMW-CC AverageMW-CC Standard Deviation1
a discussion of the linear CC which measures how
closely the point cloud “hugs” a straight line. Al- Either a low value for the numerator, or a large
though linear relationships are the type most often value in the denominator will produce a low value
explored in statistics, significant non-linear relation- for SACC. Indicators with stable predictive power
ships may exist. While the standard linear CC will will tend to have small denominators resulting in
fail to detect them, more sophisticated statistical higher SACC values. It is our contention that SACC
MTA JOURNAL i SPRING 1992 23

provides greater insight into an indicator’s utility as with the dependent variable. Therefore we defined
a market predictor than CC alone. For example, sup- the indicator as the inverse of the ratio (i.e., the ratio
pose we have two indicators. Indicator #l has an MW- of the 26 TWMA to the 4 week TWMA).
CC average of + 50 and indicator #2 has an MW-CC
average of + .25. Knowing nothing else about them Indicator Descriptions
we would be tempted to rely on indicator #l over #2. 1. CPRM (COMMERCIALPAPERRATEMOMENTUM)
But if the MW-CC of indicator #l has a standard The data series used was the weekly interest rate
deviation of .50 while that of indicator #2 is 0.125, #2 on 3 month high grade commercial paper (CP3). The
is substantially better in terms of the SACC criterion. indicator is the log of the ratio of the 26 week TWMA
of CP3 to the 4 week TWMA of CP3.
Indicator #l SACC=.50/.50=1.0
CPRM = log(26 weekTWMA CP3/4 weekTWMACP3)
Indicator #2 SACC=.25/0.125=2.0
2. FFRM (FEDERALFUNDSRATEMOMENTUM)
The Tested Indicators The data series used was the weekly federal
We have applied SACC analysis to a number of funds rate quoted on Friday (FFR). The indicator is
indicators which are defined below. Each indicator the log of the ratio of the 26 week TWMA of FFR
was correlated with a measure of the market’s future to the 4 week TWMA of FFR.
change using the MW-CC technique. The definition FFRM = log(26weekTWMAFFR/4weekTWMAFFR)
of future market change is defined below. A plot of
the MW-CC for each indicator is presented along 3. PRM (PRIME RATE MOMENTUM)
with a table comparing the SACC values. Each plot The data series used was the weekly Prime in-
has superimposed on it a regression line that depicts terest rate quoted on Friday (PR). The indicator is
the trend of the MW-CC over time and gives an indi- the log of the ratio of the 26 week TWMA of PR to
cation of improvement or deterioration in predictive the 4 week TWMA of PR.
power. An upward sloping regression line indicates PRM = log(26 week TWMA PR/4 week TWMA PR)
improvement while a downward sloping line indi-
4. DIVYLD (DIVIDEND MELD ON ~8~~500)
cates deterioration.
The data series used was the weekly yield on the
All indicators were derived from weekly data and
S&P500 stock index as quote in Barron’s.
were calculated for the period l/1/61 through
7/20/90. Indicators that involved moving averages 5. DIVBILL (DIVIDEND YIELD s&p500/3 MONTH
were generated using a triangular weighted moving TBILLS YIELD)
average (TWMA). In contrast to the simple moving The data series used were the weekly yield on
average that assigns equal weight to all observations the S&P500 stock index (DIV) and the yield on 3
in the moving data window, TWMA assigns the month tbills (BILL). The indicator is the log of the
greatest weight to the observation in the middle of ratio of dividend yields divided by tbill yields.
the window and smaller weights assigned to observa- DIV/BIL = log (DIVBILL)
tions at the end points of the window. For example
the weights in a 5 period TWMA would be: 1,2,3,2,1. 6. MFACR (MUTUALFUNDCASHTOASSETSRATIO)
Each datum in the window is multiplied by its The data series were those published by the
respective weight, these products are summed and Investment Company Institute. Cash were divided
then divided by the sum of the weights by assets and lagged by five weeks to compensate
(9=1+2+3+2+1). The advantage of the TWMA over lags in reporting the figures.
ordinary moving averages is that of it is less sensi- MFCAR=(MUTUALFUNDCASH/MUTUALFUND
tive to large differences between the latest addition ASSETS)LAG5
and deletion from the data window. All indicators
are based on the natural log. 7. HILO (HILO LOGIC INDEX)
To permit easier graphical comparison, all in- Weekly number of new highs and new lows as
dicators were defined so as to have positive correla- reported in Barron’s were used to construct an indi-
tions with the dependent variable. This involved cator developed by Norman Fosback of the Institute
defining the indicators in a manner that is the for Econometric Research. The indicator is the total
reverse of what might make the most common sense. number of issues traded for the week divided by the
For example the commercial paper rate momentum lesser of weekly new highs or weeky new lows. This
indicator might typically be defined as the ratio of ratio was smoothed with a 13 week TWMA.
a 4 week TWMA to a 26 week TWMA . This would HILO=13WEEKTWMA(TOTALISSUES/LESSEROF
produce an indicator that is negatively correlated (NEW HIGHS, NEW LOWS))

CPRM VS S&P500 FUTURE RETURN DWLD VS. S&P500 FUTURE RETURN
208 WK MOMNG WINDOW CORRELATION 208 WK MOVlNG WINDOW CORRELATION
QUARTERLY DATA QUARTERLY DATA
so , I .00
.40 .70
n .60
z+s .30 -I
oz t .50
a >
0 .20
- .40
n
cl .lO .30
v 0
1 0.00 0 .20
3
5 .lO
i
= 0.00
-.20
-.lO 1 -.lO
FFRM VS. S&P500 FUTURE RETURN DIV/BIL VS. S&P500 FUTURE RETURN
208 WK MOVlNG WINDOW CORRELATION ’ 200 WK MOVlNG WlNDOW CORRELATION
.60 _I .a I
-I .6
.40 -
I
CY
m
.30 \
LL
LL .20 >
-
c-l .lO cl
y 0.00
3 -.lO
I
-.20
-.30
-.40 - -
5 10 15 8
FFRMM
PRM VS. S&P500 FUTURE RETURN MFACR VS. S&P500 FUTURE RETURN
208 WU MO’ilNG WINDOW CORRELATION 208 WK MO’ilNG WINDOW CORRELATION
.60 j .60

8. PSSR (PUBLIC TO SPECIALISTS SHORTS SALES YCM VS. S&P500 FUTURE RETURN
RATIO) 208 WU MOVING WINDOW CORRE!vATlON
QUARTERLY DATA
Weekly values for public short sales (PUBSS) and SO
specialists short sales (SPSS) were obtained from .40

Barron’s. The indicator is the ratio of PUBSS to SPSS
smoothed with a 13 week TWMA which is lagged by z JO
two weeks to compensate for reporting lags. > .20
PSSR = 13 wk TWMA (PUBSSISPSS) lagged 2 0 .lO

0
9. YCM (YIELD CURVE MOMENTUM) $ 0.00
The data series used were the weekly rates for Z -,,.
three month commercial paper (CP3) and the weekly
-.20
rates for Moody’s AAA Corporate Bonds (AAA) ob-
tained from Barron’s. First the yield curve (YC) is -.30
calculated as the log of the ratio: YC=CP3/AAA. The
indicator is the difference between the 52 week
TWMA of YC and the 4 week TWMA of YC.
YCM = 52 week TWMA YC -4 week TWMA YC Definition of Dependent Variable:
S&P 500 Future Change
The definition of the dependent variable is critical
in correlation analysis. A particular indicator may
HILO VS. S&P500 FUTURE RETURN have significant correlations with changes over the
208 WK MOVING WINDOW CORRELATION
next five years while being uselessfor the next three
.60 months. In this research, the dependent variable is an
SO average of several time horizons to overcome a pro-
.40 blem with a single horizon pointed out by Walter C.
0
_I .30 Revis in an earlier MTA Journal article. Quoting from
-
I .20 that article “. . . focusing on one particular period of
v .lO time can result in seriously distorted impressions of
y 0.00 an indicator’s accuracy. An extreme example of this
3 would be comparing an indicator to the DJIA one year
-.lO
r in the future for the dates October 16 and October 19,
-.20
1986. Since adding a year to these dates would bring
-JO us to the day before and the day after the Crash, the
-.40 difference in the yearly return would be dramatic One
“LO
Y year from October 16, 1986 would show a return of
over 22% in the Dow Industrials. One year from Oc-
tober 19, 1986 would show a loss of over 5%, even
though the DJIA was higher on over 97% of the
trading days in between. Would it be fair to say that an
PSSR VS. S&P500 FUTURE RETURN
208 WK MOVlNG WINDOW CORRELATION indicator that was bullish on both dates in 1986 was
.60
QUARTERLY DATA only right half of the time? Obviously not.“6
In this study the dependent variable is defined as
SO
an average of future change over six different time
K .40 horizons; 1 month, 2 months, 3 months, 6 months, 9
VI months and 12 months. First the annual compounded
v, .30
a price change on S&P500 was computed for each of the
0 .20 time horizons. For example, supposeat a certain point
0 in time the S&P500 stands at 200 and one month later
.lO
i it is 210, two months later it is 207, three months later
2 0.00 it is 225, six months later it is 240, nine months later
-.lO it is 245 and twelve months later it is 220, the an-
nualized changes for each time horizon would be:
-.20
1 month annualized compounded return =
(210/200)‘2 = 80%

2 month annualized compounded return = Conclusion & Future Research
(207/2OOY = 23% The stability of an indicator’s forecasting power
3 month annualized compounded return = is an important consideration in evaluating its utili-
(225/200)4 = 60% ty and the MW-CC technique is one way to measure
6 month annualized compounded return = it. The SACC criterion incorporates stability and
(240/200)* = 44% average correlation and thus identifies indicators
9 month annualized compounded return = whose forecasting power is high relative to variabili-
(245/200)1.33 = 31% ty. Researchers who wish to pursue this area should
12 month annualized compounded return = consider investigating several facets . First, other
(220/200)’ = 10% window lengths should be looked at to seewhich are
most informative for particular future time horizons.
The dependent variable is an average of the six
Second, correlating the MW-CC curves of various in-
returns = 41.16%
dicators could provide useful information as to which
indicators might usefully be combined to form
Results
multivariate forecasting models. The idea would be
Below, in Table 1, we present the results of our
to combine indicators whose MW-CC curves are least
analysis for the period l/65 through 6189. Each indi-
correlated. This suggestion is in the spirit of Modern
cator was correlated with the dependent variable, the
Portfolio Theory7 that seeks to maximize portfolio
markets future return asdefined above. For each of the
return while minimizing return variance. It does so
nine indicators listed along the right hand side of the
by combining investments that display low levels of
chart the following five columns of information are
correlation in their return streams. In a like man-
provided;
ner, MW-CC data streams might be fed into an MPT
Co1 l-Average value of the MW-CC optimizer to find a combination of indicators that
Co1 2-Standard deviation of the MW-CC maximizes MW-CC while minimizing MW-CC vari-
Co1 3-Minimum value of the MW-CC over the ance. The optimal “portfolio” of indicators discovered
historical period could then serve as input to a multivariate estima-
Co1 4-Maximum value of the MW-CC over the tion technique which derives the functional relation-
historical period ship between the indicators and a dependent
Co1 5-SACC, a ratio of Co1 1 to Co1 2 variable. This step is necessary because MPT does
not generate a functional mapping. Conventional
multiple regression could be used as the estimation
Table 1.
method, though more advanced non-linear methods
5 could provide better results if the relationships are
Indicator Average St. Dev. Min Max SACC non-linear. The application of MPT optimization to
CPRM 0.26 0.14 -0.25 0.46 1.86 MW-CC curves give needed attention to indicators’
FFRM 0.26 0.17 -0.34 0.52 1.53 time varying predictive power and their intercorrela-
PRM 0.24 0.14 -0.40 0.52 1.71 tions. The benefit of introducing this type of infor-
DIVYLD 0.45 0.16 -0.12 0.74 2.81 mation into the multivariate modeling process could
DIV/BIL 0.38 0.25 -0.34 0.74 1.52 be models with more stable predictive power.
MFACR 0.26 0.17 -0.20 0.52 1.53
HILO 0.19 0.20 -0.32 0.53 0.95
PSSR 0.34 0.17 -0.19 0.58 2.00 FOOTNOTES
YCM 0.21 0.17 -0.21 0.47 1.23 1. For a general introduction to correlation analysis see Jerome
L. Valentine and Edmund A. Mennis, “Quantitative Techniques
for Financial Analysis”, C.F.A. Research Series, Richard D. Irwin
Inc., Homewood, Illinois, 1971 pp 85-86 or any introductory text
on statistics.
Plots of the MW-CC 2. James T McClave and F? George Benson, Statistics For Business
It is instructive to look at the plots of MW-CC and Economics, Dellen Publishing Company, San Francisco, 1985,
from which the SACC was derived. It becomes clear p. 420 and Biometrika Tables for Statisticians, Vol. 1 (2nd edition),
Cambridge University Press (1958); edited by E.S. Pearson and
just how volatile forecasting power is. We also fit a H.O. Hartley, pp 332-333.
trend-line to the data with linear regression. The 3. For example, Norman G. Fosback, Stock Market Logic, The Insti-
slope of the regression trend-line shows whether the tute for Econometric Research, Fort Lauderdale, Florida, 1985.
CC is getting better or worse over time. MW-CC plots In this work, Fosback measures the CC of numerous indicators
using the time span 1942 through 1975.
for each of the nine indicators described above are
4. “N” should be greater than 30 observations to prevent small
shown in Diagrams #2 through 10. sample size problems, but not so large that it loses sensitivity

to short-term changes in predictive power.
5. For a general introduction to non-linear modeling methods see
Shaolom M. Weiss & Casimir A. Kulikowski, Computer Systems
That Learn, Morgan Kaufmann Publishers, Inc., San Mateo,
California, 1991, or Ross M. Miller, Computer-Aided Financial
Analysis, Addison-Wesley Publishing Company, Reading,
Massachusetts, 1990, Chapter 10.
6. Walter C. Revis, “A Methodology for Creating a Master In-
dicator,” Market Technicians Association Journal, Winter
1989/1990, pp. 25-30.
7. Andrew Rudd & Henry K. Clasing, Jr., Modern Portfolio
Theory-The Principles of Investment Management, Down Jones-
Irwin, Homewood, Illinois, 1982, Chapter 1.
David Aronson is president of Raden Research GFOU~,

a firm that develops and licenses predictive model-

1
The Barron’s Confidence Index Revisited

by Bruce M. Kamich
Investors and technicians are forever interested in conditionsthat were unfavorable for the saleof more
indicators that will help forecast the markets or capital issues,and that the upturns of prices have
anticipate turning points. Some indicators lead, restoredfavorable market conditions.Thesechanges
of direction in the trends of security prices and in
others are coincident and others may lag the aver- the volumes of new capital issueshave resulted in
ages or the instrument that one is following. This cyclical fluctuations in the amounts of new money
paper focuses on the Barron’s Confidence Index as flowing into corporate enterprises.
a leading or coincident indicator of the bond futures “There is one simple test which should throw con-
market. We will explore the history of the Confi- siderable light on the degree of regularity with
dence Index from its uncertain beginnings, its which such changes of direction in the trends of
?-e-discovery” in 1959, its overuse in the 196Os, and security pricesand the volumesof capital issueshave
in fact precededthe downturns and the upturns of
the subsequent fallow years. Finally, we will look at the businesscycles.That test can be carried through
a way to use the indicator to time the bond market. by computing the data of a single line representing
The Confidence Index first appeared in Barron’s in the earlier years of the long period under review
on January 8,1932. It is reported each week in the a smoothed average of the coursesof the security
Market Laboratory section. The Confidence Index prices, and for the years sincethe early 1860’sa line
representing a smoothed average of the security
became popular in the 1960’s when Joseph Granville prices and of the capital issues?
introduced it as a stock market timing tool. In the
mid-1960’s, it was published by a number of market “According to theory the indicator line should be
moving downward as it crosseseach light vertical
services in both line and point and figure form. In dashedline, and it should be moving upward as it
conversation, Jim Alphier, the late chairman of crosseseachof the heavy ones.In nearly all the cases
Argus Investment Management said that Col. it behaves in that way, but in a few instances its
Leonard I? Ayres originated the Confidence Index changes of direction are made too sluggishly to
in 1926 or 1927. Jim Alphier also said that Ayres render that possible?
Despiteall its shortcomings the
indicator line reflects the high degree of regularity
was involved in the founding of a company called with which stock and bond prices have turned
Standard Statistics that was later merged in 1941 downward before the downturns of our business
with Poors’ becoming the famous Standard & Poor’s cycles and by doing so have created unfavorable
Corporation. market conditions for the further marketing of new
securities, and the regularity with which they have
I was unable to unearth the original ideas behind
turned upward before the upturns of the cycles and
the Confidence Index and found no citations regard- brought about favorable market conditions for
ing its use. In Leonard I? Ayres’s, Turning Points in floating new issues. For the past 75 years the line
Business Cycles, we can find some of his early think- includes the data of the new issues as well as those
ing on the topic of confidence and interest rates that of the bond and stock prices, and it continues to turn
may have inspired formulation of the confidence upward and downward with almost unbroken
regularity shortly before the upturns and downturns
index. A sample is quoted below. of the business cycles.“4
“It has long been a commonplace of financial com- The staff at Barron’s, nor a conversation with
ment that business confidence increases, and
business sentiment becomes more optimistic, when Joseph Granville shed any light on the early history
stock prices are advancing? Throughout this book and uses of the Confidence Index. In the 1960’s, the
the thesis has been developed that there is a special Confidence Index was constructed from the ratio of
significance in the fact that security prices and the the average yield on Barron’s 10 highest grade cor-
volume of new capital issues have turned downward porate bonds to the yield on the Dow-Jones 40 Bond
shortly before the downturns of most business cycles,
and that they have turned upward before the Index. Today the Index is the result of Barron’s in-
business upturns. The argument has been that the dex of 10 high-grade corporate bonds divided by Bar-
downturns of the security prices have created market ran’s index of 10 medium-grade corporate bonds.

Barr-on’s explains the Confidence Index in their pertaining to this indicator was found. Reference to
own literature as the ratio of the yield on the best the Confidence Index is not complete without an
grade bonds relative to intermediate grade bonds. appreciative nod to Lawrence Zeiberg for first call-
A falling ratio means that bond buyers are willing ing the author’s attention to the Index by lucky
to accept a much lower yield on the better-quality accident, both of us completely unaware at the time
bonds that suggests that they are losing ‘confidence’ of its significance.“5
in lesser-quality issues. The cautious element in the The 1960 Granville book goes on to explain that
market is thereby implying that it doesn’t favor low- the Index is simply pointing out the direction the
quality in general. A falling Barron’s Confidence In- smart money is moving in. When the Confidence
dex is viewed by many as a harbinger of weakness Index moves up it means that important money is
for the stock market. The reverse is also believed to moving away from the safest bonds toward more
be bullish for stocks. A rising Confidence Index speculative bonds. When the Confidence Index
suggests that astute investors are becoming more declines it means that the smart money is
willing to tolerate higher risk (since they are will- gravitating back toward the safer issues and away
ing to accept lower yields on lower-quality bonds from the speculative bonds. Correlation with the
relative to what they’ll accept on the higher-quality stock market becomes obvious. A series of advances
issue.)? in the Confidence Index is going to result in more
The use of the Barron’s Confidence Index as a money flowing into equities (gravitating toward risk)
stock market forecasting tool is associated with and a series of declines in the Confidence Index is
Joseph E. Granville. When Mr. Granville was going to result in money flowing out of equities
writing a daily market letter for E.F. Hutton & Co., (gravitating toward safety). The flow of smart money
Barron’s published on September 7, 1959 his article shows up in the bond market before it shows up in
“Market Forecaster? The Barron’s Confidence Index the stock market.
has Compiled an Uncanny Record.” In this article,
“Smart money can be identified in retrospect by
Mr. Granville tells us how to use the Index: anybody. If the stock market goes into a sustained
“The ratio is high when investors demonstrate con- advance the smart money was that money which
flowed into equities just before the rise. Conversely,
fidence by buying lower-grade liens, low when they
if the stock market goes into a sustained decline the
take refuge in top-grade issue. Correlated with the
movements of the stock market, the Index becomes smart money jumped out of stocks first. Therefore;
see what the smart money is doing in the bond
a highly sensitive forecasting instrument, predicting
the extent as well as the timing of price advances market and you will know in advance what it will
and declines. Generally speaking, changes in the do in the equity market, either come in or go out.
The Barron’s Confidence Index tells you in one week-
Confidence Index precede those in the stock market
by two to four months. . . . Repetitive bottoms or tops ly figure whether the smart money is gravitating
toward safety or risk.
in the Confidence Index usually signal very impor-
tant near-term lows or highs in the Dow-Jones Indus- “The time lag between the changes in the Con-
trial Average. . . . Major tops for the market are fidence Index weekly readings and the stock market
signaled when the Confidence Index makes a sharp average movements is subject to various durations,
weekly upswing to a new high and then retreats but the correlation theory is sound enough to
immediately the following week. . . . The low in the underscore this indicator as one of the most sensitive
Index following an unbroken series of declines is and accurate market timing devices. To emphasize
often more significant than subsequent lows made this in the broadest possible sense, the stock market
after intermittent rebounds.“” has never gone down following a lengthy series of
Index advances and the market has never continued
Granville’s, A Strategy of Daily Stock Market to rise following a series of Index declines. In the
Timing for Maximum Profit, added little to his arti- positive sense, the market has always risen following
cle, but it served to publicize the Confidence Index. a rising trend in the Confidence Index and has fallen
following a declining trend in the Index. The lead
In the preface Granville tells us more about the
time is generally two to four months.
background of the Confidence Index. “The Barron’s
Confidence Index is treated at some length as a Granville also suggests we need not get too close
primary feature, not only because of its very newness to the Index in that “It would be possible to compute
as an applied stock market indicator, but because the Confidence Index on a daily basis but in the light
of its high degree of timing accuracy, which has im- of past performance the added degree of accuracy
mediately placed it in the forefront of the major would not be commensurate with the effort.“’ Gran-
market indicators. Other than the writer’s brief arti- ville also reminds us to trust our 10 indicators and
cle on the subject (Barron’s, September 7, 1959, try to ignore the news reports - “It has been found
entitled ‘Market Forecaster?‘), no other literature that when the Confidence Index is in disagreement

with majority opinion, the record of past perfor- significant, especially if the new high or new low
mance favors the Confidence index as being the true is only maintained for that one week.
indicator in the majority of cases.“’ 14. When overlapping 60-120 day signal time areas
Granville presents 15 rules to guide you in inter- exist, the transitory nature of the shorter duration
preting the Confidence Index. C.I. swing is stressed.
1. Whatever the Index is doing is usually reflected 15. While the Confidence Index is important, it is
in the stock market between 60 and 120 days later. still only one indicator. It is the collective use of all
2. The Index is primarily useful in determining the indicators that constitutes the most enlightened
market timing, but not necessarily amplitude as market forecast?
measured by the Dow-Jones Industrial Average. By 1963, in his next book, Granville’s New Key
3. The Index is simply pointing out the direction the to Stock Market Profits, Granville gives only passing
smart money is moving in. mention to the Confidence Index. “At this juncture
4. Whatever the Confidence Index does not foresee it is interesting to note what some of the other indi-
is not important. If the Confidence Index is declin- cators were pointing to. The Barron’s Confidence
ing and the market is rallying the market offers Index called for a new high in the Dow-Jones Indus-
a selling opportunity. If the Confidence Index is trial Average sometime between June and August.“‘O
rising and the market is declining it offers a buy- For the next 25 years the Barron’s Confidence
ing opportunity. Index slowly collected dust and became a forgotten
sentiment and stock market timing tool. There is one
5. Major tops for the stock market are often signalled
study in the 1965 revised second edition of the
when the Confidence Index makes a sharp weekly
Encyclopedia of Stock Market Techniques (we are
upswing to a new high and then retreats immecli-
unsure when it was written, but the last price entry
ately the following week with an equally sharp
is March 1965). This article by Paul S. Dell’Aria, was
decline.
titled “Confidence Index - Stock Selection” and in
6. Repetitive tops or bottoms in the Confidence Index the summary the author points out, “To date, taking
usually signal very important near-term lows or into account the reappraisal of its lead time, the
highs in the Dow-Jones Industrial Average. Confidence Index has performed satisfactorily. The
7. The low in the Confidence Index following an un- lead-time curve is offered as a tool that can enhance
broken series of declines is often more significant the usefulness of the Confidence Index.” The thrust
than the subsequent lows made after intermittent of the article was to refine the lead time of the
rebounds. Confidence Index. The author found that, “Although
8. The start of long bull swings in the stock market there is no doubt that the lead time varies, the range
are more likely to be signalled by the first rises in does not necessarily fall between two and four
the Confidence Index following a long period of months, but can be greater. In fact, it can vary from
previous declining moves in the Index. as little as zero lead time to as much as a year.“”
The Barron’s Confidence Index has not been
9. Lead measurements in the case of double, triple,
widely used in the last twenty years and there have
or four-way Confidence Index bottoms, should be
been few references to the index in writing. In 1984
measured back to the last of the multiple Index
Granville co-authored a kind of autobiographical
bottoms.
book with William Hoffer. In The Book of Granville,
10. When the phenomenon of divergent Index Reflections of a Stock Market Prophet, he notes that
penetrations is encountered, it is the most recent it became overused. “If I really have unlocked the
penetration that determines the direction of the Con- secrets of the stock market, why has not everyone
fidence Index trend. followed my lead, effectively undermining my
theories? In some cases they have. Some of my early
11. Regardless of what weights the Index (second
indicators, such as the Dow Jones Rail Average and
grade rails, etc.), the validity of the stock market
the Barron’s Confidence Index, became so widely
signal is not distorted.
followed that they were no longer valicl.“12
12. When the Confidence Index is in disagreement As traders and analysts we have come to accept
with majority opinion, the record of long past per- that bullish developments for the stock market can
formance favors the Confidence Index as being the be bearish for the bond market. A strong economy
true indicator in most cases. can translate into higher earnings and higher equity
13. A penetration of a tenth of a point in the prices, but for bond traders a stronger economy can
Confidence Index is not looked upon as being too mean increased demand for money and higher

Weekly Bond Futures Prices Weekly Bond Futures Prices
66 66
51 57
85’
85
Barron’s Confidence Index Barron’s Confidence Index
1977 1978 1979 1960 1982 1983 1984 1986
interest rates. Thus, some indicators that work for From Table 1, (see page 34) note the distinct
the stock market may need to be reversed or in- change in the data from the 1977-1983 period to the
verted to generate signals for bonds. Granville found 1984-1992 period. The extreme readings marking
that bottoms or low numbers for the Confidence In- the bottoms in bond prices (high BCI readings) are
dex preceded lows in the stock market. In my in the 93.7 to 98.7 region in the latter period. In the
research, however, I found that high confidence early period bond market bottoms occurred when the
numbers were closer to bond market price lows while index fell between 91.7 and 94.1. The difference in
low numbers for the index tended to preceed highs levels might be attributed to the fact that the early
for the debt markets. phase in the bond market had a bearish bias while
It looks as we have come full circle. Can we accept the latter phase had a bullish emphasis. Another
a new use of the Confidence Index? I present my find- possible explanation for the difference in levels be-
ings above and on the next page. Examining the tween the periods was that the issues used to com-
extreme readings in the BCI for the past 15 years we pute the Confidence Index were changed. In 1984,
came up with the revealing results shown in Table I. Randall Forsyth revised the index as one of his first

Barron’s Confidence Index ’ n
ID”
1989 1990 1991
1987 1988

jobs on the Barron’s staff. It is quite possible that BIBLIOGRAPHY
the issues in the Index will be revised again since Ayres, Leonard I?, Turning Points in Business Cycles, The
some of them have been called. In interpreting the MacMillan Company, 1940
indicator in future cycles, consideration should be Dell’Aria, Paul S., “Confidence Index - Stock Selection,”
Encyclopedia of Stock Market Techniques, (Revised Second
given to the downward sloping channel that has Edition), Investors’ Intelligence, Inc., 1965
lead to higher levels for the Confidence Index at Granville, Joseph E., A Strategy of Daily Stock Market Timing
market bottoms. for Maximum Profit, Prentice-Hall, Inc., 1960
Granville, Joseph E., Granville’s New Key to Stock Market Pro-
fits, Prentice-Hall, Inc., 1963
Table I
Granville, Joseph E. with Hoffer, William, The Book of Gran-
The Confidence Index as a Tool ville, RefZections of a Stock Market Prophet, St. Martin’s Press,
1984.
for Timing the Bond Market
Krasner, Joel H., “Confidence Galore,” Barron’s, June 4, i990
Nearby Nearby
Index Futures Index Futures
Date at Bottoms Prices Date at Tops Prices FOOTNOTES
1. Leonard F? Ayres, Turning Points in Business Cycles, 1940,
10131/77 92.8 101-20 01/03/77 88.6 N/A
p. 162.
10130/78 94.1 91-24 03113178 90.1 97-22 2. Ibid., p. 156.
07123179 93.3 90-22 12124179 89.2 81-24 3. Ibid., p. 157.
03117180 93.6 69-00 12/29/80 84.0 72-07 4. Ibid., p. 161.
09114181 93.9 59-16 02/02/81 86.0 69-23 5. A promotional booklet by Barron’s showing how to use various
07109182 91.7 62-09 lo/29182 85.2 76-06 indicators and data contained in the weekly.
10128183 93.7 70-22 03104183 87.0 6. “Market Forecaster? The Barron’s Confidence Index Has
77-11
Compiled an Uncanny Record: Barron’s, September 7, 1959, p. 9.
03/02/84 96.3 68-21 07127184 90.8 64-00
7. Joseph E. Granville, A Strategy of Daily Stock Market Timing
03/01/85 95.7 68-15 12127185 91.3 85-07 for Maximum Profit, 1960, p. 114.
06113/86 93.7 94-29 11128186 89.9 98-31 8. Ibid., p. 116.
10116187 96.9 77-23 01102187 91.3 99-24 9. Ibid., p. 122-123.
08126188 97.7 84-14 01129188 91.5 93-14 10. Joseph E. Granville, Granville$ New Key to Stock Market
Profits, 1963, p. 270.
03/10/89 97.4 86-19 08/04/89 92.2 97-02
11. Paul S. Dell’Aria, “Confidence Index - Stock Selection,”
04l30190 98.7 90-23 12/10/90 93.4 96-21 Encyclopedia of Stock Market Techniques, 1965, p. 59.
06124191 96.0 93-02 10/07/91 92.9 99-28 12. Joseph E. Granville, with William Hoffer, The Book of
03/16/92 95.0 96-28 01/06/92 92.8 105-20 Granville, Reflections of a Stock Market Prophet, 1984, p. 140.
avg 77-92 95.0 89.8

avg 77-83 93.3 87.2
ave 84-92 96.4 91.8
Vice President with MCM, Inc., Bruce M. Kamich is

Conclusion responsible for the technical commentary and analysis
on MoneyWatch, a technical and fundamental infor-
After examining the 1977-1992 history of the
mation/advisory service covering the U.S. Treasury
Bar-rods Confidence Index and bond futures prices, market and delivered over Telerate. Before joining
I believe the Index is at least a good coincident or MCM, Bruce was employed as a futures and options
hedging specialist at Oppenheimer & Co., as Director
confirming indicator of tops and bottoms for bond of Research at Alto Commodities, as a technical
futures. Committing funds to the market or rais- market analyst at Merrill Lynch, and covered risk
ing cash gradually as the indicator changes should management trading at a regional government
securities dealer. He has held various positions on the
be given consideration. One possible way to use this board ofthe Market Technicians Association and cur-
data would be to go a third long when the Confi- rently serves as the President of this 600-member
dence Index reaches 95, the overall average. Another organization. Bruce has had several articles published
in the MTA Journal on specialized bond market
third long position could be purchased if the Index indicators.
rose further to 96.4 or higher, the average of the
more recent years. A final position could be acquired
when the earlier purchases become profitable. More
work needs to be done in refining entry and exit
points in the market. Smoothing the Index with
moving averages and formulating rules to reduce
the level of subjectivity would be one area for
investigation.

A “Sealed Room” and “Only One Client”
by Henry 0. Pruden, Ph.D.
In this article, I propose to offer you some opinions from here, where I had nothing but a table, a chair,
and conjectures on the following thesis: to do his or a telephone, a ticker and an air-conditioning
machine. I sealed up the windows with boards and
her finest work, a technician must have a “sealed
putty, so there would be no outside sights and sounds
room” and “only one client.” to distract me. I had no fundamental information at
my disposal whatever, which left me free to make
A “Sealed Room” up my mind solely on the basis of my charts.” Magee
We must travel north to near Boston and travel continued, “I’ve still got a lease on the Worthington
back in time to the early 1950’s so as to observe John Street Office-keep a lot of my private files there.
I’ve always hung onto it as a place where I can go
Magee seated in his famous “sealed room.” John every now and then and think-a kind of safety
Brooks, author of The Seven Fat Years: Chronicles valve, you might say. . I”
of Wall Street, found Magee there and then. From
the pen of Brooks the fable, the myth or was it the Like Wyckoff, like Schaboacker and like Neil1
fact of the “sealed room” came to be accepted as the before him, Magee ran a pennant up the flag pole
symbol of the pure technician working in a pure emblazoned “The Tape Tells All”! To tell the truth,
technical world. to interpret the true message of the market, all
This is how Brooks told the story of his first Magee required was the price, volume and time of
meeting with John Magee: transactions, all of which were available from the
ticker tape. With price, volume and time, Magee
“Hanging on the wall nearby was a bulletin could create daily charts and weekly charts, he could
board, on which were posted several notices, written
then go on to draw trend lines, mark levels of sup-
in symbols too esoteric for me, and a motto, not so
esoteric, that read, ‘MY MIND IS MADE UP, DON’T port or resistance, and, then, finally, elevate all into
CONFUSE ME WITH THE FACTS. ’ a fantastic geometric typology-wedges, triangles,
“Magee gave me an owlish glance and pointed head-and-shoulders, saucers and so on and on.
to the motto on the bulletin board. ‘So, you see, in But why has the metaphor of the “sealed room”
a sense there’s as much truth as humor in that,’ he lingered for so long? Why do the words “sealed room”
said. ‘Of course, the sign is just a gag and is intend- evoke such warm and knowing familiarity among
ed as a rebuke to know-it-alls, but to the technician
the last part of it has a special significance and in some technicians and vivid mental images among
a peculiar way means what it says-“Don’t confuse others?
me with the facts. Facts, as used here, are the daily The answer to these questions lies, I believe, in
outpouring of newspaper stories and radio news the allegorical qualities of the story of the “sealed
bulletins dealing with announcements of mergers, room.” An allegory is a story in which figures and
reports of earnings, decisions in tax cases-all that
sort of thing-to say nothing of a great variety of opi- actions are symbols of general truths. It is a method
nions and predictions and just plain scuttlebutt. of indirect representation of ideas as truths.
Even if you could separate the hard core of fact from The upshot of the story of the “sealed room” is
the chaff of scuttlebutt, you would find that much that you need your own private space, your own
of it is irrelevant-information that is either trivial “sealed room,” free of the noise, interferences, com-
or, more often, has already been noted, evaluated,
and acted on, and thus has been reflected by the petitions and expectations of the external world, so
market, days, weeks, or even months before it that you can do your best technical thinking. You can
reaches you. ‘Discounted in advance,’ as Wall Street best organize yourself for effective decision-making
says. It is simply so much confusing dross to the by first creating for yourself in your own mind your
technician, who therefore does his best to avoid it. own version of the sealed room.
“Let me give you an example,” said Magee.
That you can achieve superior technical results
“Before I came to work here, I was on my own,
making my charts and operating in the market out by retiring to the treasure chest of your own “sealed
of an office at 350 Worthington Street, a few blocks room” is no small accomplishment. It promises you

an opportunity to shift your state of mind into that technical analysis, to create wealthy and happy
zone where superior performance is naturally clients, to make a better world.
fostered. In his article on “Finding ‘The Zone’ ” (NY “ ‘It’s not what the vision is, it’s what the vision does:
Times, April 9,1989), Lawrence Shainberg recounts Truly creative people use the gap between vision and
how Denise Parker, a diminutive, world-class archer current reality to generate energy for change.
finds her zone. According to her coach, Keith “As Somerset Maugham once said, ‘Only mediocre
Henschen, an applied sports psychologist: people are always at their best!’
“ . . . athletes who do best are the ones who get into “Everyone has had experiences when work flows
the zone most easily.” (Her coach asked Denise) fluidly; when he feels in tune with a task and works
with a true economy of means. Someone whose
“. . .to create for herself what he called a ‘happiness
room,’ a place to which she could withdraw in her vision calls him to a foreign country, for example,
imagination in order to visualize an upcoming meet. may find himself learning a new language far more
rapidly than he ever could before. You can often
Of all the exercises this was the one to which Denise
brought the most enthusiasm. The room she created recognize your personal vision because it creates
such moments; it is the goal pulling you forward that
(in her mind) was primarily a replica of her bedroom,
makes all the work worthwhile.
but it had its magical dimension, and it was
anything but austere. ‘There’s stairs leading up to “But vision is different from purpose. Purpose is
it and these big doors you go through,’ she explains. similar to a direction, a general heading. Vision is
‘It has brown wall-to-wall carpet, a king-sized a specific destination, a picture of a desired future.
waterbed, stack stereo, a big screen TV and a VCR, Purpose is abstract. Vision is concrete. Purpose is
posters of Tom Cruise and Kirk Cameron on the wall, ‘advancing man’s capability to explore the heavens.’
and a fireplace that’s always blazing. That’s where Vision is ‘a man on the moon by the end of; the
I go when a meet’s coming up. I drive up to it in a 1960’s.’ Purpose is ‘being the best I can be,’
Porsche, go inside, lie down on the waterbed and ‘excellence.’ Vision is breaking the four-minute mile.
watch a tape of myself shooting perfect arrows. Later, “It can be truly said that nothing happens until
when I get to the tournament, everything seems there is a vision. But it is equally true that a vision
familiar. Even at the Olympics I was calm as soon with no underlying sense of purpose, no calling, is
as I began to shoot.’ “’ just a good idea-all ‘sound and fury,’ signifying
Like Denise, your “sealed room” can be your nothing!“3
“happiness room;” like Denise, you can create your Let us wend ourselves more deeply into an
sealed room in your mind; like Denise, you can out- exploration of your purpose and your clients. At the
fit your sealed room with all the modern gadgetry bottom there may well exist a curious love-hate rela-
and wizardry you wish; like Denise, you can retire tionship between you and your clients. You are the
to your “sealed room” at any time, but particularly expert, they are novices, or so the reasoning goes,
before major events; like Denise you can run movies for otherwise why should they buy our advice? Your
of yourself making the perfect market calls time superior knowledge presumably gives you power, yet
after time after time, or, if you prefer, you can run modern marketing philosophy states that the con-
mental movies of those times in the past when you sumer, your client, is king! You want to be rational,
made your best calls, you did your best work, you felt your clients too often are emotional!? You want to
you were in sync with the market. focus and concentrate your energies, but too many
diverse clients are always scattering your attention
Only One Client and efforts. You may have a solid track record and
Within your mind there should exist a vision of a method for generating reasonable, consistent
yourself achieving your defined purpose. Such a results, yet potential clients avoid you and current
vision has magnetism, it has the power to pull you clients leave you as they flock around the guru with
toward its fulfillment. To be most magnetic, such a the latest hot hand. You are dependent upon your
vision should depict you accomplishing your heart’s clients, but you may prefer to affiliate with your
desire-for example, imagine seeing yourself receiv- peers; you may wish to stand tall in the timer
ing the MTA Award, feeling the congratulatory ratings.
handshakes from Bob Prechter and Marty Zweig, Now let us walk into a bookstore and purchase a
and exchanging messages of trust, respect and copy of a forward-thinking management text, The
mutual admiration with your clients. Such a vision Fifth Discipline: The Art and Practice of the Learn-
engenders commitment, raises standards, enlivens ing Organization, by Peter M. Senge. Between its
a creative search for better solutions to problems, be covers can be found an assortment of nuggets of
they technical, personal or monetary. Such a vision wisdom. Take purpose for instance. The author
generates the creative tension you need to call forth implores you to extend the boundaries of your ego
your best efforts, to push forward the frontiers of and function, you end up widening your circle of

compassion. By expanding your boundaries of com- or at least the customer-client part of you, are the
passion you end up seeing clearly how you and your proxy for all of your other clients. That is a respon-
client are enmeshed in the same system of mutual sibility. Consistently serve that one client very well
dependence. Out of this sense of expanded boun- over the long-term and you’ll serve all of your other
daries also springs a commitment to the whole, clients.
which will make your sense of purpose a real Think of it this way. If you are by yourself,
motivating force. trading for your own account, you are, in the final
As Senge goes on to say, . . . genuine commit- analysis, doing it for some larger purpose. That
ment is always to something larger than ourselves. larger purpose is fulfilling the needs of the consump-
The sense of connectedness and compassion char- tion side of your business, the customer. Your larger
acteristic of individuals with high levels of mastery purpose is inextricably tied to fulfilling broader
naturally leads to a broader vision. . . . Individuals client needs, be they safety needs fulfilled by money
committed to a vision beyond their self-interest find in the bank, affiliation needs met by caring for your
they have energy not available when pursuing nar- loved ones or even philanthropic needs satisfied
rower goals. through charitable donations. Cut a corner, cheat
Viewing your technical efforts from the client’s your customer and you cheat yourself. So much for
perspective is a commitment to the truth. It means the duality of yourself as customer and company.
a relentless willingness to root out ways we limit or But your vision of yourself as your best and most
deceive ourselves from seeing what is, and to con- worthy client will only enhance your decision mak-
tinually challenge our theories of why things are the ing if it becomes an internal part of you. Writing
way they are. It is broadening our awareness, it is down, “I am the customer, I am the company” as a
expanding our boundaries, it is taking another motto, then placing that affirmation everywhere
observation of our work from the outside looking in. along your daily path is not a bad idea. But the real-
But how do we reconcile what is, the culture of ly good idea, the idea which will give that motto
the client-customer relationship on Wall Street, with some punch is to have it installed in your mind, in
what should be, a wider, deeper sense of purpose one or more of your primary senses of seeing, hear-
which incorporates your client as a partner in your ing and feeling. Let’s do a simple exercise to get this
progress? Ipropose that you simplifjl your life down point across. At this moment create a mental picture
to %nly one client.” Then incorporate that “bne client” of an ideal client in your mind’s eye. Focus on the
into your personal vision of achievement, and into head and shoulders. Now center this picture of your
your statement of purpose. ideal client as though it was appearing on a one-
“You are the customer, you are the Company,” million dollar bill. Can you make the client look a
exclaimed Paul Hawken in the title to a chapter in little more like you? Can you place that image of
his book, Growing a Business. Hawken went on to your ideal client in your upper visual field alongside
make the following observations: an image of yourself? If you did those exercises, you
were creating an internal visual representation. On
“In order to develop a good business idea and earn
the permission of the marketplace, yoou must be the the other hand, if you were unable to make mental
market. You should want to shop at the store you run, images or if you were unhappy with this picture-
to receive the services you offer. Every expression making process, then try words or feelings instead.
of the business, its ads, decor, service, packaging, Develop somewords to represent your client, like “he
pricing, and selling techniques should be 100% credi- is a jolly good fellow.” These words, like your con-
ble, respectable, and acceptable to YOU.“~
science speaking, will come up to remind you of your
And further on Hawken said that: purpose, your vision. Or maybe you’ll be reminded
of your vision by how you feel, by a tingling sensa-
“While you ‘approximate’ the customer, you can tion in your arms or a thrill through your solar
know only yourself. So stay close to the person you plexus. Best of all, develop all three internal repre-
understand, and market products for yourself. This
sentations of your “only one client“-see him, hear
takes the guess work out of it.“5
him, feel him.
Hawkin is calling our attention to the fact that The next facet of your vision calls for constant-
we too are the clients of your own technical products, ly, continually maintaining a vivid image of your
that we too should shop, critically, at the windows growing, thriving client or client-self. A hallmark
of our technical enterprises. We should repeatedly of effective decision-makers/successful people is a
ask ourselves: would I buy that? does it meet my capacity to sustain their vision, to have it as a handy
standards as a client? If it does not, then change it. reference against which to check their decisions.
You, yourself are that “one client.” You, yourself, Their vision is both now in the present and out there
MTA JOURNAL ! SPRING 1992 37

in the future; it is focused on ends and results rather or several hundred miles away from your city, or
than upon ways and means. both. Remember to have a positive mental attitude;
An effective decision-maker is so bound to fulfill- remember to relish the creation of your “sealed
ing his larger mission he will make the needed room.”
adjustment in ways and means. For example, if 2. Focus your attention on “only one client.”
reversing a market opinion is needed to fulfill the Imagine this client growing wealthier and living a
vision of a prospering client, the opinion will be thriving lifestyle. Commit yourself to the enhance-
amended; if abandoning a pet technical approach is ment of this client’s welfare. Develop an image of
required to reach the future vision, so be it; if dif- yourself as this ideal client or being with that client.
ferent time-frames or styles of trading or even if a See you or both of you moving along a path of con-
bullish bias must be surrendered to fulfill the vision, tinual growth and thriving. Use this image as a
appropriate change will be made. And the effective, benchmark for the choices you make. Each day
visionary decision-maker will accept these and renew this vision until it is there for you always and
numerous other “mistakes” in stride; he’ll accept automatically.
them as learning opportunities along the path to the
fulfillment of his compelling future. This article is based upon a paper delivered at the 16th Annual
Any decision you make should be tested against Market Technicians Association Seminar, Santa Barbara, Cali-
fornia, May 3, 1991.
that vision. If the contemplated action leads toward
the fulfillment of that vision, it is an effective deci-
sion; if the contemplated action leads away from the FOOTNOTES
fulfillment of that vision, it is an ineffective decision. 1. Brooks, John, The Seven Fat Years: Chronicles of Wall Street,
Harper and Row, 1958, pp. 1466147.
Your vision of you and your client on the face of
2. Shainberg, Lawrence, “Finding ‘The Zone’ “, lVew York Times,
a $l,OOO,OOO bill can serve as the trigger which April 9, 1989, p. 1.
causes you to generate multiple options of the future, 3. Senge, Peter M., The Fifih Discipline, Doubleday, 1990, p. 153,
your vision can be the standard against which you p. 207.
measure those options, your vision can be the 4. Hawken, Paul, Growing a Business, Simon and Schuster, 1987.
motivator which pulls you into action. 5. Ibid.
The stronger and richer the image of your “only

client, yourself,” and the more deeply rooted, the BIBLIOGRAPHY
more pure and the more single-minded your purpose, Bandler, Richard and Grinder, John, Frogs into Princes: Neuro-
the more likely that this entire decision-making pro- linguistic Programming, Real People Press, 1979.
cess will become automatic for you. Maintaining the Edwards, Robert D. and Magee, John, Technical Analysis of Stock
Trends, John Magee, 1966.
image of “only one client” will work to harness the
immense powers of your unconscious mind.
DI: Pruden is a speculator and an educator He is a
member of the MTA and of the TSAA of San Francisco.
Conclusion Dr Pruden frequently teaches classes on technical
Reflecting back upon this discourse may bring analysis at Golden Gate University in San Francisco,
to light some insights worth considering. There may California.
be some truth to the picturesque notion of making
a habit of slipping away to your own special redoubt,
your own sealed room. From there you can sally forth
with the foremost technical forces which you and
your myriad of technical resources can muster. And
the direction you choose is determined by the vision
in your mind’s eye, namely “only one client.” The
vision I see for you is you as the best technician or
trader or investor you aspire to become. I see you
doing this by serving to your utmost capacity a
vision of your client or both of you together.
If you find merit or even hope in the notions of
a “sealed room” and “only one client,” then you
might wish to consider two helpful hints:
1. Identify an exclusive place for yourself that
you can call your “sealed room.” This place can be
located a few feet away from your computer screen

The Impact of Commodity Prices on Bonds and Stocks-
An Intermarket View
by John J. Murphy
The intent of this article is to explore relatively new leading indicator of stocks. It further suggest that
ground in the analytic process-intermarket link- bond prices are heavily influenced by the action in
ages among the various financial markets-and to the commodity pits. Because bonds are so sensitive
study the logical sequence of events that often moves to inflation, there exists a generally inverse relation-
from commodities to bonds to stocks. The value of ship between bond prices and commodity prices.
intermarket analysis to a trader or investor is to aid That being the case, the intermarket analyst studies
him or her in seeing and understainding the world these three market sectors together. This article
of markets in a broader, more revealing fashion. attempts to show how closely related these three sec-
Although other analysts have applied a more rigor- tors are, and why it’s useful for stock market techni-
ous statistical approach to this subject, this article cians to keep an eye on bonds and commodities.
will rely on price charts to present a visual analysis
of the relationship between commodities and bonds, The Strong Link Between
and then between bonds and stocks. Inasmuch as Commodities and Bonds
this is a new and exciting area for technical analy- A strong link exists between commodities and
sis, it is regarded as both pioneering and explora- bonds. The bond market is extremely sensitive to
tory. Hence the assertions made in the following text inflation. Rising inflation usually produces lower
are believed to be true. Further historical research bond prices and higher yields. Falling inflation
and real time experience will strengthen some links, pushes bond prices higher and yields lower. Com-
weaken others, and reveal many other heretofore modity prices are generally regarded as a leading
unsuspected links among markets. The author indicator of inflation. Since commodities traded on
encourages other students of technical analysis to the various commodity exchanges represent raw
join him in the never-ending process of creating and materials at their first stage of production, it stands
testing hypotheses concerning intermarket analysis, to reason that that’s where the first hint of inflation-
and to share those insights and findings with fellow ary trends will usually emerge. One of the com-
technicians through the pages of this Journal. modity indexes that is widely-utilized to measure the
Traditional technical analysis has an inward direction of the general commodity price level is the
focus in the sense that analysis is usually performed Commodity Research Bureau Futures Price Index.
on a “single market” basis. That approach treats The CRB Index includes 21 commodity markets,
each market as a separate entity. Stock market all of which are traded on commodity exchanges. Vir-
technicians focus their attention on the market itself tually all actively-traded commodities are included
to determine its probable future direction. Bond in the CRB Index. Although the 21 markets are
traders naturally concentrate their technical equally weighted, the three groups that have the
analysis on the bond market. Commodity traders greatest impact on the CRB Index are the metals,
study the charts of gold, oil, soybeans or whatever the oils, and the grain markets. For that reason, it’s
commodity they’re trading. Each group usually especially important to monitor the activity of those
limits its analysis to the particular market it is three sectors. At certain times, any one of these three
following. Intermarket analysis takes a more out- sectors can dominate the commodity scene and will
ward focus by suggesting that there is “value add- play a crucial role in the inflation picture. During
ed” by combining the analysis of all three sectors. 1988, the grain markets dominated because of the
Intermarket work pays close attention to the drought in the midwest. During 1990, the oil
price action in surrounding markets. It suggests that markets were dominant because of the Persian Gulf
stock market technical analysis should be sup- war. For longer range intermarket comparisons,
plemented by a corresponding analysis of the bond however, it’s best to use the CRB Index or some other
market, since the bond market often acts as a composite index as the proxy for commodity price
MTA JOURNAL i SPRING 1992 39

trends instead of relying on the movement of any one lows in bonds was suspect. In this case, technical
commodity market or sector. analysis in one sector (commodities) is used as a
It should be noted that one of the criticisms of check on technical analysis of another (bonds).
the CRB Index is its heavy weighting of agricultural Bearish readings in the CRB Index during the fall
markets. Many analysts prefer to use a commodity of 1990 (line 3) provided an early bullish warning
index that measures only the direction of industrial for bonds. Line 4 shows the beginning of a downturn
commodities, such as the Journal of Commerce Index in bonds during March of 1991, which coincides with
or the CRB Industrials Index. Although I prefer to an upturn in the CRB Index.
utilize the CRB Index, it’s important to monitor all
commodity indexes for confirmation. At times, when Long Term Rates Versus the CRB Index
the intermarket relationship between the CRB Index Since bond prices usually trend in the opposite
and bonds, for example, appears to be “out of sync” direction of commodity prices, it follows that bond
it pays to emphasize other indexes. An example of yields usually trend in the same direction as com-
one such situation that occurred during the summer modity prices. Figure 3 shows the positive correlation
of 1991 will be discussed later in the article. between the CRB Index and long term interest rates
(30-year bond yield) that existed form early 1989 to
Visual Comparison of Bonds early 1991. Notice how the CRB Index led turns in
and the CRB Index the bond market at the end of 1989 (line 1) and at the
Figures 1 and 2 provide a visual comparison of 1990 peak (line 2). The divergence between the CRB
the CRB Index and Treasury bond futures prices. Index and interest rates, described in the preceding
The intent is simply to show the inverse relation- paragraph, during the fall of 1990 (line 2) can be seen
ship that usually exists between the two sectors. more clearly on this chart. Bond yields set new highs
When commodity prices are rising, bond prices are while the CRB Index didn’t. Clearly, bond traders
usually falling. Conversely, falling commodity prices (and economists) would have benefited at that point
are usually bullish for bonds. Figure 1 shows the by glancing at their commodity charts. Line 3 in
five years from 1987 through March of 1991. The Figure 3 shows the upturn in long term yields during
vertical lines pinpoint the important turning points. March of 1991, which coincides with a corresponding
Line 1 shows the collapse in bond prices during the upturn in commodity prices.
spring of 1987, which was accompanied by a bullish
breakout in the CRB Index. During the summer of Bonds Versus Stocks
1988, the peak in the CRB Index (coinciding with The stock market is sensitive to interest rate
the end of the midwest drought and a major top in trends. Figures 4 and 5 reveal an apparent positive
the grain markets) helped launch a major rally in correlation between bond and stock prices. Visual
bonds (line 2). analysis also suggests that bonds led stocks, at least
Lines 3 and 4 show two other turning points dur- during the five years under study, That being the
ing the second half of 1989 and in March of 1991. case, technical analysis of bond prices can be an
In all four instances shown on the chart, turns in important ingredient in an analyst’s outlook for
the bond market were accompanied by turns in the stocks. Figure 4 compares Treasury bond futures
CRB Index in the opposite direction. Figure 2 pro- prices to the Dow Industrials from 1987 to the first
vides a closer look at the related market action from quarter of 1991. While both markets usually trend
the summer of 1989 to the first quarter of 1991. Once in the same direction, serious divergences between
again, the inverse relationship can be seen. the two should be noted.
Line 1 shows that a CRB upturn during August In order to understand the significance of a
of 1989 coincided with the beginning of a double top divergence between bonds and stocks, it is necessary
in bonds. A CRB peak during May of 1990 coincided to recognize the strong tendency for bonds to change
with a bond bottom (line 2). Line 3 shows two impor- direction well before stocks, sometimes by several
tant pieces of information. The first is simply that months. That being the case, it is possible for bonds
the downturn in the CRB Index during the fall of and stocks to periodically have divergent trends.
1990 coincided with an upturn in bonds. The second That apparent decoupling is usually nothing more
has to do with divergence analysis. During Sep- than bonds changing direction before stocks, and pro-
tember of 1990, bonds dropped below their spring viding an early warning of a similar turn in stocks.
lows. The rally in the CRB Index, however, was well A dramatic example of bonds turning down before
below its spring high. stocks, forming a bearish divergence in the process,
That bearish divergence by the CRB Index was seen in 1987.
provided an early indication that the move to new Figure 4 shows that the stock market peak in

igure 1 Figure 2
s-year comparison of the CRB index (solid line) to Treasury bond A P-year comparison of the CRB Index (solid line) to Treasury bond
ltures prices (dotted line). Bonds and commodities UsuallY trend futures (dotted line). The inverse relationship between bonds and
I opposite directions. The verticle lines how that turns in bonds commodities can be clearly seen, especially at turning points.
re accompanied by opposite turns in the commodity markets.
:igure 3 Figure 4
/ l-year comparison of the CRB Index (solid line) to long term in- A strong correlation can be seen between stocks (solid line) and
erest rates (dotted line). A strong positive correlation can be seen bonds (dotted line) during these 5 years. The bond market usual-
metween commodity prices and Treasury bond yields. ly leads important turns in the stock market.

August of 1987 was preceded by a bond collapse in the usual inverse relationship between commodity
April of the same year. What appeared to some to prices and bonds seemed to disappear. Figure 7 com-
be a “decoupling” turned out to be an early warn- pares the CRB Index to bonds during the spring and
ing to others. Both markets rallied together from summer of 1991.
late 1987 to late 1989. The double top in bonds at A peak in bonds during February of that year
the end of 1989 marked the actual top in several coincided with a trough in the CRB Index which is
broader stock averages. However, the divergence dur- the normal pattern. However, the CRB Index and
ing the summer of 1990 (line 2) is especially strik- bonds then dropped together into the June/July bot-
ing as the Dow’s rally to new highs was unconfirmed tom, contradicting their usual tendency to trend in
by the bond market action. Figure 5 provides a more opposite directions. The analyst knows that both
detailed comparison from the end of 1989 to the markets rarely trend in the same direction for very
beginning of 1991. The second peak in the bond long, but isn’t sure which one to trust. At such times,
market (line 1) in December of 1989 led a selloff in it’s a good idea to consult other commodity indexes
stocks by a week. A more serious bearish divergence to see if they are confirming the trend in the CRB
between stocks and bonds was seen during the sum- Index. A glance at Figures 8 and 9 immediately
mer of 1990 (line 2). clears up the apparent mystery. Both charts employ
Figure 5 also shows that the stock market upturn two industrially-weighted commodity indexes which
in October of 1990 was preceded by an upturn in give a very different picture than the CRB Index.
bond prices (which, in turn, was accompanied by a Figure 8 compares the CRB Industrial Futures Index
falling CRB Index). To the upper right of the chart, to bonds. That index includes copper, cotton, crude
a divergence can be seen developing between rising oil, lumber, platinum, and silver. Notice how that
stock prices and falling bond prices during March commodity index maintains a clear inverse relation-
of 1991 (accompanied by a rally in the commodity ship to bonds.
markets.) Figure 9 compares the Journal of Commerce
Index to bonds with the same result. The JOC In-
CRB/Bond Ratio Versus Stocks dex includes 18 raw industrial prices. Like the CRB
The interplay between the CRB Index and bond Industrial Futures Index, the JOC doesn’t include
prices tells us a lot about the inflation picture and any agricultural markets. During the spring of 1991,
provides a useful indicator for stock market direc- activity in the agricultural markets distorted the
tion. Figure 6 is a relative-strength ratio between the CRB Index, causing the usual relationship to bonds
CRB Index (numerator) and Treasury bond prices to be disrupted. This is one example of why it’s so
(denominator). When the CRB Index is outperform- important to monitor all commodity indexes for con-
ing bond prices and the ratio is rising, inflation firmation. The upward spike in the grain markets
forces are building and long term rates are nudging during the summer of 1991 also caused a mislead-
upward. That scenario usually has a bearish impact ing blip in the CRB Index. Notice, however, that the
on stocks (see lines 1, 2, and 4 in Figure 6). A fall- peak in both industrial commodity indexes during
ing CRB/bond ratio has the opposite meaning, and the summer of 1991 coincided with the upturn in
has a positive influence on stocks (see lines 3 and bond prices. This raises the natural question of why
5 in Figure 6). Arrow 6 in Figure 6 shows the ratio one would use the CRB Index at all. My work sug-
line rising during March of 1991, suggesting the gests that over a long period of time, the CRB Index
likelihood of some bearish pressure on the stock has the closest correlation to the bond market and
market. bond yields than either of the industrial-based
indexes. The CRB Index has also on many occasions
The Summer of 1991 Revisited led turns in the industrial markets by several
As in the application of any indicator or analyti- months. Nonetheless, it’s important to monitor all
cal technique, there are times when usually reliable commodity indexes.
relationships appear to break down. Admittedly,
even the most reliable intermarket relationships An International Dimension
seem to disappear for short periods of time. At such There’s another explanation for that spring
times, the analyst has little choice but to rely on slump in U.S. bond prices, which introduces another
more traditional analytical methods until the more aspect of intermarket analysis-the need to monitor
normal intermarket relationships come back into global markets. During the summer of 1991,
line. At other times, the apparent discrepancy can economists and analysts were puzzled by the bond
be resolved by deeper investigative work. One such market slump. The American economy was in reces-
situation developed during the spring of 1991 when sion, inflation wasn’t a concern, commodity prices

Figure 5 Figure 6
A comparison of stocks (solid line) and Treasury bonds (dotted The CRB Index/bond ratio (bottom chart) compared to the S&P
line) during a %-year span. Bond led stocks at most important tur- 500 Index (upper chart). A rising ratio is bearish for stocks (points
ning points. 1, 2, and 4). A falling ratio is bullish (points 3 and 5).
3c USC 99024 283
Figure 7 Figure 8
During the spring and summer of 1991, the CRB Index and bonds During the spring and summer of 1991, the CRB Industrial Futures
trended in the same direction, contradicting their normally inverse Index maintained its inverse relationship to the bond market and
relationship. was more useful than the CRB Futures Price Index for intermarket
comparison with the bond market.

were slumping. Bond prices should have been rising. positive effect successive discount rate cuts have had
However, an analysis of global bond markets re- on the stock market. Successive hikes in the discount
vealed that the U.S. bond market was simply parti- rate have ultimately proven to be bearish for stocks
cipating in a major global bond correction. Figure (witness Edson Gould’s “Three Steps and a Stumble
10 compares U.S. Treasury bonds to British bonds. Rule”). Given the tendency for short and long term
Notice how closely the two markets resemble each rates to trend in the same direction, the impact of
other. By placing the U.S. market into a global discount rate moves on the stock market is just
perspective, a different picture emerges. The major another way of stating the link between interest rate
bond market rally in the U.S. during the summer direction and the stock market.
of 1991 occurred simultaneously with most other
world bond markets. Martin Pring’s Six Stages
An excellent explanation of the chronological
The Rotation Between Bonds and Stocks rotation between bonds, stocks and commodities is
During 1991 given by Martin Pring in his work entitled Asset
Market events during 1991 provide an example Allocation and the Business Cycle (published by the
of the rotation that normally takes places between International Institute for Economic Research, PO.
bonds and stocks and the need to understand their Box 329, Washington Depot, CT 06794). Pring
normal relationship. (See Figure 11). Arrow A shows describes six stages of the business cycle and what
bonds turning up slightly before stocks during the happens to each asset class during each stage. Stage
fourth quarter of 1990. Arrow B shows the dip in 1 (during recession) sees rising bond prices. Stage
both markets that preceded the outbreak of the 2 is characterized by rising stocks. Stage 3 sees rising
Mideast war in January, 1991 and the subsequent commodities. Stage 4 has bond prices peaking. Stage
rally in both markets shortly after the war broke out. 5 shows stocks peaking. Stage 6 is identified by
Arrow C shows that the February peak in bonds cor- falling commodities (during the onset of recession).
responds roughly with the beginning of a ten month That analysis suggests a rotation where bonds turn
consolidation period in the Dow Jones Industrial first at peaks and troughs, stocks second, and com-
Average. The second half of 1991, however, provides modities last. Viewed in that way, bonds become a
an excellent example of why it’s so important to leading indicator for stocks, stocks become a leading
understand the rotation that normally takes place indicator for commodities and, to complete the cir-
between stocks and bonds. cle, commodities become a leading indicator for
Bonds rallied in July of 1991 but had little imme- bonds. That rotational sequence is also supported by
diate impact on stocks. Six months later, however, the work of Dr. Geoffrey H. Moore, Director of the
stocks moved to record highs. It is at such times that Center For International Business Cycle Research
an understanding of the rotation between bonds and at Columbia University.
stocks becomes vitally important. Bonds and stocks
didn’t “decouple” during the second half of 1991 as Business Cycle Research
many analysts argued. Bonds were simply perform- In his book entitled, Leading Indicators for the
ing their normal role as a leading indicator of stocks. 1990s (Dow Jones-Irwin, 19901, Dr. Moore, one of
During recession, bonds usually turn up months this country’s leading authorities on the business
before stocks. During the bond rally, interest-sensi- cycle, presents research supporting the chronologi-
tive stocks do especially well. At some point, traders cal sequence between bonds, stocks and commodities
begin to sense an economic rebound, and money described in Pring’s six stages that forms the basis
flows from bonds to stocks. During that second stage, for intermarket analysis. In the eight business
stocks play “catch up” with bonds as asset alloca- cycles since 1948, Dr. Moore tracked the perfor-
tors switch from interest-sensitive stocks to cyclicals. mance of bonds, stocks and commodities as leading
indicators of turns in the business cycle at peaks
The Effect of Discount Rate Changes and troughs. What he found was that bonds turn
Arrow E in Figure 11 shows bond futures clear- first at peaks and troughs (with an average lead
ing long term resistance at 101 in December of 1991, time of 17 months), stocks are second (with an
registering a 4-year recovery high. That bullish average lead time of seven months), while com-
breakout in bonds and the accompanying surge by modities, measured by the Journal of Commerce
the Dow Industrials to record highs were caused pri- Index, turn third (with an average lead time of
marily by the full point discount rate cut by the six months). Dr. Moore’s research supports one of
Federal Reserve Board on December 20 of that year. the basic premises of intermarket analysis, namely
Many analysts have published research showing the that bonds, stocks and commodities are not only

Figure 9 Figure 10
The Journal of Commerce Index of 18 raw industrial prices also The downward correction in U.S. Treasury bond prices during the
maintained an obvious Inverse relationship with bonds during the first half of 1991 and the subsequent recovery during the second
first half of 1991. The July peak in industrial commodities coin- half of that year coincided with similar activity in global markets
cided with a ma)or trough in bond prices. such as the British bond market.
linked, but peak and trough in a predictable, rota-

tional sequence.
Conclusion
An extension of this discussion on intermarket
analysis could include many other subjects. The im-
pact of the U.S. dollar and overseas currencies, as
well as the activity in global bond and stock markets
are other subjects for consideration. The link be-
tween certain stock market groups and commodities,
such as oil and gold shares to crude oil and gold, as
well as the relationship between interest-sensitive
stock groups, such as the utilities, and bonds could
also be considered. Intermarket analysis should play
an important role in the asset allocation process.
John Murphy has been a MTA member for 10 years,

having served on the Board of Directors for 6 of those
years. He is the author of Technical Analysis of the
Futures Markets (Simon & Schuster, 1986) and Inter-
market Technical Analysis (John Wiley & Sons, 1991).
This article is based on research published in the lat-
ter book. John is president of JJM Technical Advisors
Figure 11 which is based in Oradell, N.J. He is also the regular
technical analyst for CNBCYFNN-TV where he does
L comparison of bond prices and the Dow Industrials during 1991. daily broadcasts on the financial markets.
‘he bond peak in February marked the beginning of the IO-month
:onsolidation in stocks. The bond rally during the second half of
1991, followed by the stock market rally in December (sparked
my the December 20 discount rate cut), demonstrates the tendency
or bonds to lead stocks.

NOTES

NOTES

NOTES

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SPRING 1992 ISSUE 39

A PUBLICATION OF THE MARKET TECHNICIANS ASSOCIATION

Issue 39 Spring 1992

John R. McGinley Michael J. Moody, CMT

Frederick Dickson, CMT David Upshaw, C.F.A., CMT

Richard Orr, Ph.D. Anthony W. Tabell

Henry 0. Pruden, Ph.D.

MTA JOURNAL / SPRING 1992 1

ELIGIBILITY: REGULAR MEMBERSHIP is available to those “whose professional efforts are

Receive Monthly MTA Newsletter Yes Yes

Receive MTA Journal Yes Yes

Use of MTA Library Yes Yes

Participate on Various Committees Yes Yes

Eligible to Chair a Committee Yes No

Eligible to Vote Yes No

Colleague of IFTA Yes Yes

2 MTA JOURNAL / SPRING 1992

MTA Editorial Policy

Style For The MTA Journal

Mail your manuscripts to:

MTA JOURNAL ! SPRING 1992 3

Board of Directors, 1991-92

President Vice-President/Long Range Vice-President/Seminar

Treasurer Secretary MTA Office Manager

Programs Education Marketing

Accreditation IFTA Liaison Regional

Membership Placement Past President

4 MTA JOURNAL / SPRING 1992

Instability in the Moving Window Correlation

Railroad Track Charts: The Barron’s

MTA JOURNAL / SPRING 1992 5

The Impact of Commodity

6 MTA JOURNAL/SPRING 1992

MTA JOURNAL / SPRING 1992 7

8 MTA JOURNAL / SPRING 1992

Introduction of these extremes, for the eight days in question. In

In what follows we will show that the daily range

MTA JOURNAL / SPRING 1992 9

FIGURE 1. EIGHT DAY RANGE

FIGURE 2. INSTABILITV FIGURE 3. VOLATILITY

10 MTA JOURNAL / SPRING 1992

MTA JOURNAL / SPRING 1992 11

stability or volatility is in the fourth or fifth quin-

12 MTA JOURNAL / SPRING 1992

Overview must constantly shift his or her attention between

Most are now available in chart programs for per-

MTA JOURNAL / SPRING 1992 13

CHART VERSION 2.1 CHART VERSION 4.1

CHARTVERSION 1.5 CHART VERSION 3.5 CHARTVERSION 4.5

14 MTA JOURNAL / SPRING 1992

80- OVER-EXTENDED CONDITION -80

MTA JOURNAL / SPRING 1992 15

16 MTA JOURNAL / SPRING 1992

WEEKLY DATA -55

MTA JOURNAL / SPRING 1992 17

18 MTA JOURNAL / SPRING 1992

MTA JOURNAL / SPRING 1992 19

20 MTA JOURNAL / SPRING 1992

Introduction practical use. Consider an indicator which has a

MTA JOURNAL / SPRING 1992 21

(d) Weak Negative

22 MTA JOURNAL / SPRING 1992

MTA JOURNAL i SPRING 1992 23

24 MTA JOURNAL / SPRING 1992