MTAJOURNA

III
1111 Winter-Spring 1997 Issue47 l

A Publication of

MARKETTECHHlClAKS ASSOCIATIOIl,IKC.
One World Trade Center . Suite 4447 . New York. NY 10048 l Telephone: 212/912-0995 . Fax, 212/912-1064 l e-mail: shelleymta@aol.com
A Not-for-Profit
Professional
Organization
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7973
 Market Technicians Association Journal
Table of Contents

MTA Journal Editor and Reviewers 3

MTA Member and Affiliate Information

About the MTA Journal 5

MTA Board of Directors

Editorial Comment 7
Towards Painless Publishing
David L. Upshaw, CFA,CMT,Associate Editor

Combining Departure Studies into Power-Gram 9

Jon Knudsen, CMT
In this paper the author reviews the fundamental elements of cycleanalysis.He then showshow to
I combine several departure studiesinto a new indicator called a Power-Gram.

A Comparative Study of Simple Rate of Change versus Weighted Rate of Change Indicator 13

2
Thomas L. Hardin, CFP,CMT
The purpose of this paper is to explore someadaptations to the Simple Rate of Change indicator with
a goal of improving its long-term success.

Volume-Weighted Relative Strength Index

3
Russell R. Minor, CMT
In this paper the author placesOn BalanceVolume (OBVT)in a Relative Strength Index (RSI) format
to create a Volume Weighted Relative Strength Index (VWRSI).

Dividends Matter. Does Anyone Care? 25

Gregory J. Roden

4 This paper explores the relationship between dividend $elds and subsequenttotal returns. The
author then ponders the current low dividend yield and speculatesupon the future relationship of
dividends and price.

MTA JOURSAL l \Gnter - Spring 1W’i

 Market Noise. Can It Be Eliminated and At What Cost? 33
Jeremy J. A. du Plessis, CMT
After reviewing the traditional methods employed by technical analyststo reduce market noise, the
author presentsa simple, innovative method of objectively removing noise from data and imestigates
whether the resultswarrant it as a method that non-mathematicianscan employ.

Sector Analysis Using New Highs and New lows 49

Frank Teixeira, CMT

6 This paper explores the use of SectorNew High and New Low data for spotting changesin sectorsof
the market. The author usesdivergence, momentum, and/or relative strength to quantify buy and
sell signals.

MTA JOCRXAL * M-inter - Spring 1W

 Market Technicians Association Journal
Winter - Spring 1997 . Issue 47

Editor
Henry 0. Pruden, Ph.D.
GoldenGate Universify
Sun Francisco,Cal$xxia

Associate Editor
David L. Upshaw, CF,4, GMT
Lake Quivira, Kansas

Manuscript Reviewers

Connie Brown, CMT Don Dillistone, CF,4, CMT Michael J. Moody, CMT
AerodynamicInvestmentsInc. CormorantBay Dory, Wright & Associates
Gainesville, Georgia Winnepeg,Manitoba Pasadena,California

John A. Carder, CMT Charles D. Kirkpatrick, II, CNT Richard C. Orr, Ph.D.
Topline Investment Graphics Kirkpatrick and Compaq Inc. ROME Partners
Boulder; Colorado Exe& L%U Hampshire BeverLy,Massachusetfs

Ann F. Cody John McGinle7; George ‘4. Schade, Jr., CMT

Invest Financial Corporation Technical Trends Scottsdale,Arizona
Tampa,Florida Wilton, Connecticut

Robert I. Webb, Ph.D.

AssociateProfessorand Paul TudorJonesI1 Research Fellow
McIn tire Schoolof Com’merce, University of Virginia
Charlottesville, Virginia

Publisher
Market Technicians Association, Inc.
One n70rld Trade Centq Suite 4447
New York,NIU York 10048

MTA JOURNAL l \Cinter - Spring 1997

 Market Technicians Association, Inc.

Member and Affiliate Information

Member analysis, but who do not fully meet the requirements

for membership or currently do not know three MTA
Member category is available to those “whose pro-
members for sponsorship. Privileges are noted be-
fessional efforts are spent practicing financial techni-
low.
cal analysis that is either made available to the invest-
ing public or becomes a primary input into an active Dues
portfolio management process or for whom techni-
Dues for Members and Affiliates are $200 per year
cal analysis is the basis of their decision-making pro-
and are payable when joining the MTA and thereaf-
cess.” Applicants for member must be engaged in ter upon receipt of annual dues notice mailed on July
the above capacity for five years and must be spon-
1. College students may join at a reduced rate of $50
sored by three MTA members familiar with the
with the endorsement of a professor.
applicant’s work.
Application Fees
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Applicants for member will be charged a onetime,
Affiliate category is available to individuals who are
nonrefundable application fee of $25; no fee for af-
interested in keeping abreast of the field of technical
filiates.

Benefits of the MTA

Members Affiliates
I Invitation to MTA educational meetings Yes Yes
I Receive monthly MTA Newsletter Yes Yes
I Receive MTA Journal Yes Yes
I Use of MTA library Yes Yes
I Participate on Various Committees Yes Yes
I Colleague of IFTA Yes Yes
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I Eligible to vote Yes No

Annual subscription to the MTA Journal for nonmembers - $50 (minimum two issues).
Single issue of the MTA Journal (including back issues) - $20 each for members and affiliates, and $30
for nonmembers.
 About the MTA Journal

Description of the MTA Journal

The Market Technicians Association Journalis published

by the Market Technicians Association, Inc., One World
Trade Center, Suite 4447, New York, NY 10048. Its
purpose is to promote the investigation and analysis of
the price and volume activities of the world’s financial
markets. The MTA Journalis distributed to individuals
(both academic and practitioner) and libraries in the
United States,Canada, Europe and several other coun-
tries. The MTA JournaZ is copyrighted by the Market
Technicians Association and registered with the Library
of Congress. All rights are reserved.

A Note to Authors about Style

You want your article to be published. The staff of
the Journalwants to help you. Our common goal can
be achieved efficiently if you will observe the follow-
ing conventions. You’ll also earn the thanks of our
reviewers, editors, and production people.
1. Send your article on a disk if you can. If you send
typewritten work, please use 8-l/2” x 11” paper.
DOUBLE-SPACE YOUR TEXT. If you use both
sides of the paper, take care that it is heavy enough
to avoid reverse-side images. Footnotes and refer-
ences should appear at the end of your article.
2. Submit two copies of your article.
3. All charts should be provided in camera-ready form
and be properly labeled for text reference.
4. Greek characters should be avoided in the text and
in all formulae.
5. Include a short (one paragraph) biography. We
will place this at the end of your article upon pub
lication. Your name and affiliation will appear be-
neath the title of your article.
We will consider any article you send us, regard-
less of style, but upon acceptance, we will ask you to
make your article conform to the above conyentions.
Mail your manuscripts to:
Dr. Hem-y Pruden
Golden Gate University
536 Mission Street
San Francisco, CA 94105

MTA JOCRW l \Vinter- Spring1997 5

 Market Technicians Association
Board of Directors, 19964997
Officers 81Administrator
PRESIDENT VICE PRESIDENT/SEMINAR
Philip Roth, CMT hIark Scott
Dean Witter Reynolds The \‘olume Investor
2 World Trade Center, 63rd Fl. 3 Piedmont Center, #210
New York, NY 10048 Atlanta, GA 30305
?12/392-3516, Fax: 212/392-1458 404/231-1207, ext. iO9
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Andrea Seumann TREASURER
HSBC Futures Inc. J. Les Williams, CMT
140 Broadway, lith Fl. FVilliams Capital hjanagement
New York, N’Y 10006 P.O. Box 120125
212/825-5880, Fax: 212/825-0650 Arlington, TX i6102
817/548-8332, Fax: 815/795-7411
Committee Chairpersons
ACCREDITATION IFTA LIAISON
>Iargaret yan Andel, CFA, CMT Philip Erlanger, CMT
Dal’inci Investments Phil Erlanger Research
43 \Vaite Road P.O. Box 2680
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NewYork, NY 10019 508/528-8678,Fax: 508/528-6914
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6 MTAJOURNAL * \\‘inter - Spring 1997
SECRETARY
Dodge Dorland, CMT
LANDOR Investment hlgmt.
103 East 75th Street, #4F/E
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MTA AMINISTRATIVE OFFICER
Shelley Lebeck
Mar-ket Technicians Association
One M’orld Trade Center, #443T
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PLACEMENT
James Bohan.
h4errill Lynch
World Financial Center, North Tower
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212/449-0552, Fax: 212/449-2767
PROGRAMS
\jyalter Burke, CMT
MCM Money\yatch
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New York, NY 10005
212/9084325, Fax: 212/9084331
REGIONS
James Bianco, CMT
Arbor Trading Group Inc.
1000 Hart Road, #260
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847/3041511, Fax: 847/3041574
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hlChl hloneyWatch
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LEGAL CONSULTANT
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Matlins Financial Consulting, Inc.
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EDITOR’S COMMENTARY
Towards Painless Publishing
by David L. Upshaw, CFA,CMT, AssociateEditor

We Want to Make You Famous before you send it to us. Saving work to a
No passion in the world is equal disk does not always result in having your
These two quotations express the rela-
to the passion to alter someone paper look like vou want it to look. Onlv
tionship that can exist between writers and else’s drafi. material that relates to your article should
their editors. Writers can easilv think that
be on your disk.
editors are out to torment them. Editors,
sitting injudgment of someone else’s ideas, I often say that when you can mea- Treat Your Readers to Great
can afford the luxury of thinking that writ- sure what you are speaking about, Graphics
ers just don’t know how to express them- and express it in numbers, you Charts (arhvork) should be submitted
selves. (As one who has walked on both know something about it; but when with your final draft right off your com-
sides of this street, I know that it’s easier you cannot express it in numbers,
puter if you are creating your own graph-
to criticize than to come up with some- your bwledge is of a meagre and
ics. They should be black on white with-
unsatisfactory kind; it may be the
thing original.) out any grayscale. These charts will be
beginning of knowledge, but you
The staff of the MTAJow-nnl assures all scanned into your text. Avoid photo-
have scarcely in your thoughts ad-
of you who want to have your research copies; they don’t scan as well as you, or
uanced to the stage of Science,
work appear in your publication that we we, would like. The saying about one pic-
whatever the matter may be.
heartily welcome your papers. We are here ture and 1,000 words is trite but true. Text
- Sir William Thomson, Lord Kelvin
to support you; we aren’t out to make your can be edited for spelling, grammar, and
With thanks to hthur Mwill
writing lives miserable. FVe’d like to be- clarity, but we can’t do much with poorlv-
lieve that you aren’t out to get us, either. conceived, sloppilyexecuted charts except
Here are some thoughts on what you can if you’ll just remember that two spaces are ask you to do them over. Technicians love
do to get into print with as little fuss as better than one. charts. They are great communication
possible. This is essentially a longer ver- tools. Make sure that yours are properI!-
sion of the material found on page 3 of Begin With a Paper Copy; labeled and that they are related to some-
End With a Disk
this issue of the Journal. That page has thing in your text. X stand-alone chart that
Submit your article on paper, but please
been rewritten, but because it’s a standard isn’t at least mentioned in the text is a mys-
keep a copy of it on disk if you are using a
page and thus apt to be ignored, I stress a tery that we have to take the time to solve
computer. Make sure the paper copy TOU
few points here in the hope that aspiring before we can publish it.
send us is the latest version you have on
writers will read them.
your disk. M’e have actually seen paper How to Describe the Past
Let’s Get Spaced Out copies that were three or four drafts old, Let’s leave mechanics and go to writ-
T&ed work should be double-spaced. and which bore only a passing resem- ing style. Many writers use the present
Unless vou have tried to edit single-spaced blance to what was on the author’s disk. tense when they are describing events that
text, vou have no idea of the frustration After all revisions are made and your ar- occurred in the past. U’e really don’t know
an editor experiences when there’s no ticle is accepted, we will ask you for a copy if these past events will repeat themselves,
space in which to make a suggested cor- of it on disk. Having a paper copy also or not. A statement such as “when event
rection. Set your line spacing to “2” and helps us to know what you want your tables X occurs, event B happens” would be bet-
get on with it. This is a very simple thing to look like; sometimes, tables print from ter if it read “in the past, when event A
to do, but it helps tremendously Will we a disk in untabbed form and it’s impossible occurred, B followed much of the time.”
kick your article back if it’s single-spaced? to sort them out. One more thing about It’s proper to state the percentage of the
Of course not. But you’ll do us a big favor disks: please review your work on the disk time that B followed A, if you have the data

MTA JOURXAL l ITinter - Spring 1997 7

to support the statement. The SEC com-
pels certain types of firms to stress that
“past performance is no guarantee of fu-
ture result-s” in their advertising, and for
good reason. Just keep in mind that you
can accurately describe the past, but you
shouldn’t, in good conscience, describe
the past using the present tense.
We All learn From Mistakes
I recently read about an inventor (Tho-
mas Edison, I think) who was asked
whether or not he was discouraged at the
failure of his, let’s say 200th attempt to
make a workable battery He said, “Sot at
all. Now I know 200 ways how not to make
a battery.” Not all research projects work
out the way one would hope, as thousands
of wastebaskets full of discarded printouts
attest. We will gladly consider your article,
even if your project didn’t work out the
way you hoped it would. Your reporting
of fair-to-poor results may keep someone
else from going down that path. Knowing
what has notworked can be useful to some,
if not all, of your readers.
Comparisons Give Perspective
“How’s your research?” “Compared
with what?” Some writers state the results
of a strategy compared with the results of
owning a market index over the same time
period. There’s nothing wrong with this
technique; it gives readers a frame of ref-
erence. There is another comparative
technique that I think is less frequently
used, but which also can convey some use-
ful information: the showing of what
would have happened if one had done
nothing except hold a long or short posi-
tion in the security or commodity being
tracked. For example, let’s say a certain
trading technique produced a 50% gain
over one year, with ten trades. If the trad-
ing technique beat the best buy-and-hold
approach by a large factor, that’s one thing.
3ut if buying and holding over the same
;ear produced results close to the results
,f the active technique, that’s quite an-
Ither, particularly when trading costs and
.ax consequences of ten trades versus one
Ire considered. You may want to consider
;his approach if it seems appropriate.
Long or Short?
“How long has this been going on?” is
the question asked in one of Gershwin’s
songs. How long should your article be?
As long as it takes to tell us what you want
us to know, and no longer. There is no
minimum or maximum word count. The
reviewers and editors will suggest cuts (or
additions) if they seem to be necessary \2’e
urge you to use as many words as you need,
or as few as you need, and let us work with
you on the length of the final draft. It’s
been my experience that good research
reports are tightly organized and make
their points with relatively few words. Pa-
pers that ramble around the research land-
scape before reaching their objectives are
not as easy to understand, and may not
hold the attention of readers who are
pressed for time. Still, length is not a
prime consideration in the early stages of
reviewing and editing your article. M’rite
it the way you want to tell it.
The MXiJo~~wl has come a long “a!
from its founding, thanks to writers who
have been willing to tell us what they’ve
discovered. There’s a lot to be learned
about our craft, and all of us who are pri\i-
leged to work for the jozo-wzl look forward
to spreading the news. M’e invite you to
join in the fun.
MTA JOCRSAL * LVinter - Spring 19%
 Combining Departure Studies into Power-Gram
Introduction
This pa/w,- will reuim the fundanwntak of
qcIp analysis and show how to combine seueral
departure studies into the development of a neu
indicator calkd Power-Gram. The construction
and characteristics of Power-Gram will be PX-
amined in detail, concluding with a rmiew of
ongoing research into a/$&cations.
Background
Cyclesare everywhere. They come in
many forms, and are typically stated as
fixed periods, but they actually represent
averagesof historical observations. Com-
monly accepted cycles are tides, moon
revolutions, heart beats,and four seasons
of the year. Markets are driven in the long
term by cyclical behavior in fundamental
factors affecting a particular market (in-
ventories, inflation and interest rates). In
the short term, cvclesreflect shiftsin crowd
psychology as the majority oscillatesbe-
tweenexcessiveoptimismand overbearing
pessimism.The Foundation for the Study
of Cycles(FSC) statesthat “cycle research-
erscalculate that mostmarketsare SO-85%
cyclical and 15-20%random.” Therefore
the application of cycle techniques ma!
offer insight into market movementspast,
present, and future.
X quick wayto discovera cycle isto first
perform a visual inspection or to apply a
Ehrlich Cycle Finder (an accordion type
tool) to indicate the most likely dominant
cycles.This procedure shouldbe repeated
severaltimesto yield severalcyclesof varv-
ing length. The visually detected perio&
are usedto detrend the data. One of the
mostpopular waysof detrending is to per-
form a departure analysis. Departure
analysisisaccomplishedby applying a cen-
tered moving averageof a length equal to
the visually detected period. The moving
averageis subtracted from the closeand
the remainder is plotted as a histogram.
The highs and lows of the histogram will
reveal cycle highs and lows. Several de-
parture analyseswill have to be performed
to identify and veri$ the dominant cycles.
Other more mathematicallyintensemeth-
odsare FastFourier Transforms(available
on Computrac) or SpectralAnalysis (FSC
hasa program availablecalled BasicCycle
Analysis).
Jon Knudsen, CMT
Once the cyclesare verified, the quali-
tiesof the cyclesshouldbe examined. The
key qualities are amplitude, period, and
phase.Amplitude isa measurementof the
height of a cyclefrom low (trough) to high
(crest). Period measures the time between
lows. Phasedeterminesthe time location
of a wave (rising, cresting, falling,
troughing). A cycle’s strength is deter-
mined by dividing the amplitude by the
period. The higher the number, the more
significant the cycle is in explaining price
movement.
Statisticalmeasuresmay be performed
upon the selectedcrclesfor determination
of statistical significance and validitv.
These testsare F-Ratio (standard de&-
tion), Chi-Square(phaseconsistency),and
Bartels (phaseand amplitude). Of these
various tests,Bartelsisthe singlebestmea-
sureof a cycle’sauthenticity.
One of the primaT cycle principles is
the Principle of Summation,which states
that price movement is the simple addi-
tion of all active cycles. Most marketshave
at leastfive dominant cycles.John Murph!
classifiedthesedominant cyclesand their
periodicity as long-term (2-t years); sea-
sonal (1 year); primary/intermediate (9-
26 weeks); and trading (4 weeks). Walt
Bresserthasdiscoveredthat somemarkets
have a l/2 primary cycle, whoseperiodic-
ity lies between the primary and trading
cycles. In addition, Bressertstatesthat the
trading cycle breaks down into 2 cycles
called alpha and beta. Richard Mogey has
classifiedfour types of key cycles. These
are Beat, Timing, Swing, and Trend. In
the stock indices the periods (in market
days) for thesecyclesare Beat - 5.39;Tim-
ing - 14.99;Swing- 23.1; Trend - 77.
Power-Gram
While centered departure analysisis
usefulfor determining precisecycle highs
and lows,its inherent time lag due to the
centering operation reducesits timeliness
asa trading indicator. Non-centered de-
parture analysis(NCDX) providescurrent
information with no lag, similar to a basic
momentum study. We can combine sev-
era1NCDAsinto Bsingleindicator, adher-
ing to the Principle of Summation,called
Power-Gram. Power-Gramprovides infor-
MTA JOURNX 0 \\‘inter - Spring1997
mation about cycle amplitude and domi-
nance, divergence,and overbought/over-
sold extremes in the market. However,
Power-Gramdoesnot provide a basisupon
which forecasts of successive turning
points into the future may be made.
Rather, Power-Gramseries as a reactive
indicator that will alert the analyst/trader
to significant shifts in the cyclical behav-
ior or potential directional changesin the
market under study.
Power-Gramis plotted bp summingthe
current strength readingsof the dominant
cycles. A cycle’sstrength is measuredb\
dividing its amplitude (or NCDX) bv its
period. Thisformula, CS7= [ (close-ma7)/
71whereCS7= Cycle Strength of the 7 da)
cycle, close = today’s close, ma7 = 7 da!
moving averageof close, and 7 = moving
average period used ‘7, determines the
strength of a sevendaycycle. Power-Gram
is the addition of all selected dominant
cycles’ strength. PG = CSYtCS13tCS23,
where dominant cycle periods are 7, 13,
and 23 (seeTable below). Power-Gramis
plotted as a histogram. The name arose
becausewe are following the cvcles’ net
power and that it isplotted asa histogram.
June 94 U.S. T-Bonds
Calculation of Non-Centered Departure
Analysis (NCDA)
close= 10415/32
ma7 = 105-15/32
NCDAT = (10415/32 - 105-15/32)
NCDA7 = -1.OO
Calculation of Cycle Strength (CS)
CS7 =[(104-15/32 - 10515/32)/Y]
cs7 = [ (-1.00)/7]
CS7 = -.1428
Calculation of Power-Gram
PG = (CS7t CS13tCS23)
PG = (-.1428t -.0377t -.0248)
PG = -.2053
Plotting NCDX based on each indi-
vidual dominant cycle gives great insight
into the phasing and amplitude of each
cycle independently, and when liewed as
a completepicture (Power-Gram)the cycle
controlling the present price movement
mar be easilydetected. First, observeeach
9
cycle individually and look for oscillation around zero. If the Chart1 BPPRN Daily l/10/97 C=1.6830 -.0178 0=1.6830
observed cycle is’oscillating, check the longer term cycles’ behav- H=1.6840 L=1.6718 V=5,209 Mov Avg 1 Line 1.6705
ior. If all obsewed cycles are in conflicting phases (some positive
and others negative) or oscillating, then a trading range is under-
way and Power-Gram will exhibit short term oscillations around
zero (Chart 1). Price will usually follow the strength of longer
term cycles, however (while in a trading range) if the longer term
cycles’ strengths are diminished, be alert for the short-term cycles
failure to oscillate as an early indication of a trend developing.
But if a majority of cycles are in a positive or negative phase (each
cycle’s NCDA above or below zero), then a trend is in progress
and Power-Gram will remain above or below zero for an extended
period (Chart 2). Therefore, explosive movements (all dominant
cycles in synchronization) and choppy trading ranges (opposing
cycles) may be more easily explained and anticipated. Trend
strength can be determined by examining the longer cycles once
a trend has commenced. As a trend develops, extend the cycle
focus length. Once a lessening in trend strength has been de-
tected, then begin to focus on shorter duration cycles for price
indication. Power-Gram’s direction (up/down) can be useful for
verifying the short term trend, while positive or negative ralues
reflect the longer term trend.
Divergence may be easily seen in both NCDA of each observed
cycle and Power-Gram (Chart 3). The short term NCDX will func-
tion as an early warning system, while divergence in Power-Gram
indicates a potential major trend change. Amplitude extremes
in NCDAs and Power-Gram are useful as olerbought/ol-ersold
indicators. Once an extreme has been reached, one should be
alert for a dnrergence or reversal to develop (Chart 4).

Conclusion
Current research is focused on using Power-Gram as a base Chart 2 GC.PRN Daily l/10/97 C=360.20+1.40 0=359.60
upon which to construct a trading system. Power-Gram is attrac- H=360.60 L=359.30 V=48,264 MovAvg 1 Line 370.45
tive since it provides an oscillating price cuwe with a majority of
noise removed and a minimum amount of lag. Power-Gram can
be smoothed by applying a simple mo\ing average to minimize
the occasional whipsaws and using a momentum indicator on the
moling average to provide a leading indicator (reflects slope
changes in the moling average) (Chart 5). One may also appl!
Gerald Xppel’s moling average convergence divergence technique
(MACD), with Power-Gram as the price input, and using a histo-
gram of the difference between the averages as a leading indica-
tor. Initial research shows promise lvith Power-Gram identiQing
turning points with a high degree of accuracy with a smoothed
Power-Gram functioning similar to Stochastics’ %D-Slow but re-
flecting a combination of cycles versus a single cycle (Stochastics).
However, one must be careful in selecting cycles to track. Too
many short cycles will result in a high frequency of trades. If the
desired frequency of trades is too great, adjust the cycle composi-
tion to focus on longer term cycles by either adjusting the weights
or utilizing longer term cycles. My preference is to utilize longer
term cycles, avoiding an over-optimization trap.

MTA JOURNAL * \Cinter - Spring 1995

 Chart 3 CD.PRN Daily l/10/97 C=.7446 t.0014 0=.7428 Chart 5 USPRN Daily l/10/97 C=llO"ll -1"02 0=111"17
H=.7459 L=.7415 V=6,067 Mov Avg 1 Line .7414 H=111"21 L=109"26 V=432,758 Mov Avgl Line 112*20

*c.“D.I”*“,,*.O1~l- b

Chart 4 SPPRN Daily l/10/97 C=766.60 t7.70 0=748.60

H=767.00 L=747.90 V=81,210 Mov Avg 1 Line 750.98

MTA JOURNAL I\‘inter - Spring199:

l 11
 Footnotes
1. Foundation for the Study of Cycles, Basic
Cylt A nalpis soflware manual, Cojyigh t
1991, pg. Appendix C-i.
2. J.M. Hurst, The Profit Magic of Stock
Transaction Timing, Copyright 1970, Pub-
lished by Prentice-Hall, Inc., pg. 32.
3. JohnJ Xlurphy, Technical Analysis of the
Futures Markets, Copyright 1986, Pub-
lished by Xew York Institute of Finance,
Prentice-Hall, Inc., pg. 430.
4. AJurphJ,pg. 430.
5. Foundation for the Study of Cycles,pg. Ap
pendix C-8.
References
Analvzinc and ForecastirwFutures Prices,
by Anthony Herbst. Copyright 1992.
Publishedby John Wiley & Sons.
BasicCycle Analrsis software manual, by
Richard Mogey and Foundation for
the Study of Cycles, Inc. Copyright
1991. Published by The Foundation
for the Study of Cycles,Inc.
Investing with a Computer, by Herb
Brooks. Copyright 1984. Publishedb!
Petrocelli Books.
Mesaand Trading Market Cvcles,byJohn
F. Ehlers. Copyright 1992. Published
by John L\‘iley & Sons,Inc.
The Profit Magic of StockTransactionTim-
iq, bp JA4. Hurst. Copyright 1970.
Publishedby Prentice-Hall, Inc.
RealTime FuturesTrading, byAl Gietzen.
Copyright 1992. Publishedby Probus.
TechnicalAnalysisof the Futureshlarkets,
by John J. Murphy. Copyright 1986.
Publishedbv NewYork Institute of Fi-
nance, Pren’tice-Hall,Inc.
Jon E. Knudsen, CMT
Jon Knudsenis a \‘ice Presidentof
Alternative Investments within The
ChaseSlanhattanBank’sprivate bank.
Mr. Knudsen joined Manufacturers
Hanover Futures, Inc. (a division of
Manufacturs Hanover Bank, which
later merged into Chemical Bank,
which then merged into The Chase
Manhattan Bank) in 1986,working on
the trading floor of the ChicagoMer-
cantile Exchange (the CME). From
1988 to 1989,Mr. Knudsenmanaged
the Eurodollar Options Trading Desk
and wasa member of the Index and
Options Market Division of the CME.
In 1989,Jlr. Knudsen transferred to
New York to managefutures based,
yield enhancement fixed income
portfolios within the private bank. Mr.
Knudsenalsomanagedoffshorecom-
modiw funds and coordinated deriva-
tive investment strategiesfor the pri-
vate bank’s investment management
areas. Mr. Knudsenreceived a Bach-
elor of Sciencein BusinessXdminis-
tration in Finance from the Uniter-
sitv of Denver.
MTA JOURYAL * Ii-inter - Spring1997
 A Comparative Study of Simple Rate of Change
versus Weighted Rate of Change Indicator
Introduction
Onefa~f @on which market technicians can
a,gree is that markets and srruvities go through
periods during zohich theirpvires mozvein trends.
Foryars, market researchers have studied such
trends and cyclesfrom man! diffprent persper-
tizles. ‘1s a result, many studies hazvebeen pub-
lished that pant@ the surress of using dijfer-
ent trending indicators to help predict the direr-
tion ofprice changes before thq oc~uv: The uast
use of computers during the ’80s and ’90s has
made price behavior vnuch easier to evaluate and
monitor.
One terhnical indicator used to monitor this
behavior is the rate of change or momentum
indicator The general purpose of this indica-
tor is to detervnine when a stock and/or index
has bepln moving rapidly in one direction or
anothen or to detert the slowing or nwrsal of a
preoiousl~ strong trend. Theosetirally this is a
trend indicatorpointing to both strong uptrends
and strong downtrends. The purpose of this
paper is to explore some adaptations to the
Sivnple Rate of Change indicator zoith a goal of
ivnprozring its long-term success.
Calculation
Before we discuss the calculation for the
FVeighted Rate of Change indicator, we
must first have a common understanding
about how to calculate a Simple Rate of
Change. The most common calculation
compares the current price of a stock or
index to its price sometime in the past.
The following formula is used:
Simple Rate of Change
Current price I previous price
The result of this equation is a number
that fluctuates around the number 1.0.
Atry number above 1 .O indicates an upward
trending stock or index and, comersel!;
any number below 1.0 indicates a down-
ward trending stock or index over time pe-
riod used for the rate of change measure-
ment.
Simple Rate of Change (SROC)
Many books have been written about
the use of this indicator. The most basic
use is to buy a stock when the rate of
change is above 1.0 and sell when it drops
below 1.0.
Thomas L. Hardin, UP, CMT
;2ccording to a study presented in The Weighted Rate of Change
Encvclonedia of Techn’ical Market Indica- Current Price/summation of [Price L-1Week]1
m, a 31-week period was the optimum. x (Periods - “x” Week)/ summationof
This result was reached after testing peri- (Periods “x” Week)
ods ranging from 1 to 78 weeks using the The above formula does not just look
New York Stock Exchange Composite In- at one price in the past, it looks at even
dex from Januan, 5, 1968, to December price for the number of periods back to
31,1986. The benchmark comparison was the current price. In addition, the most
made to a -10~week simple moving average weight is placed on the most current price
crossol-er rule. The 31.week rate of change back, and the weight diminishes to the old-
did outperform this benchmark, but suf- est price used. An example of the calcula-
fered substantially worse drawdown. An tion follows for a 5week LVeighted Rate of
explanation given for the I-olatilit) in re- Change on current S&P 500 Index data.
sults was the fact that the indicator put too
much weight on the price in the past. For M’eighted Rate of Change
example, if the current price was rising Sample Calculation
moderately but the price 31 weeks ago was Date Index
rising rapidly, the rate of change value 11/19/95 399.95
would drop. This could be a false signal. 11/12/95 6OO.Oi x 5 = 3,000.35
Another disadvantage of using a trend 1 l/05/95 392.72 x 4 = 2,370.88
indicator for imesting is that, by the na- 10/29/95 590.55 x 3 = 1,571.71
ture of its construction, investors miss the 10/22/95 jig.70 x 2 = 1,159.30
beginning of the uptrend. The trend must 10/G/95 387.46 x 1 = 58’7.36
first turn positive and persist for some time
Sum 15 8,889.80
before trend indicators move investors into
the market. In addition, sell signals come 12’ROC = 599.97/(8,889.80/15) = 1.01
some time after the market has turned
south. This can have a significant effect To further improve the indicator, after
on profits. This problem suggests that the rate of change value was calculated, a
trend indicators should possibly be used moving average was applied to the indica-
in conjunction with other indicators that tor. This helped eliminate an excessive
could indicate oversold markets for better number of trading signals and whipsawing
entry points and overbought markets for in and out of the market.
better exit points.
Regardless of the above discussed draw-
backs in this indicator, it does work SLIC-
cessfully. In addition, another benefit is
its simplicity. The calculation is easy to
perform, all technical analysis software has
the indicator available, and the buy and
sell decision is very clear and easy.
Weighted Rate of Change (WROC)
The purpose of my work was to create
an adaptation to the Simple Rate of
Change indicator with the goal of improv
ing performance. To do so, tests were per-
formed using a variation of the Simple
Rate of Change calculation. The variation
was created to attempt to eliminate the
problem of too much weight being placed
upon the price in the past. The following
formula was used:
MTA J0URN-K l \\‘inter - Spring 1997 13
 sition of $5,591 from a starting point of for the rate of changeindicator.”
Testing and Results Sl,OOOin January 19iOfor a compounded The EncvcloDediaof Technical
annual return of 6.98%. This isa respect- Market Indicators
Weighted Rate of Change able resultfor a singleindicator. Commis- Robert 117 Colby nud Thorns .+I.
Optimization sionsand taxeswere ignored during these A1fe~et:r
Standard & Poor’s 500 back tests. Appendix B
January 1970 -June 1995 Rate of Change Optlmcat~on The following table showsthe results
Wks SROC WROC 15-wk MA - xc of back testing the \\‘eighted Rate of
25 4505 3276 3356 . ‘hF35 Changefor severalweeklyperiodsand sev-
26 4392 3490 3684 era1moling averagesper period. The eq-
27 4264 3693 3855 uit!- value is for June 1993.It is the result
28 4126 3801 4036 of $1,000invested in January 1970.
29 4051 3829 3830
30 4022 3966 4323 WROC Mov. Avg. Equity in
31 4029 4053 4674 (weeks) (weeks) June 1995
32 3878 4113 4662 23 8 2’739
33 3692 4175 5034 25 9 2975
34 3707 4280 5592 25 10 3341
35 3702 4192 5410 25 11 3281
The M’eighted Rate of Change indica-
36 3745 4035 4858 25 12 3237
tor improves upon a Simple Rate of
37 3628 40'76 4698 25 13 3337
Change calculation. It can be practicall!
38 3656 4013 4665 25 14 3352
applied to both stocksand indexes. Be-
39 3566 3941 4389 25 15 3356
causeusing only this trading rule results
--- 25
40 3511 3924 4409 16 3859
in returns lessthan a buy-and-hold strat- -
egy it is suggestedthat it be usedin con- 26 8 2996
SROC = Simple Rate of Change 26
junction with other indicators. As dis- 9 31i5
WROC = Weighted Rate of Change 26 10 3391
15-wk MA = 15-week Moving Average cussedabol-erelative to the Simple Rate
SROC & WROC values indicate the ending value of 26 11 3431
of Change indicator, successcan be im-
$1000 invested at the beginning of the time period. 26 12 3211
proved by usingan indicator that can help
26 13 3277
an investor determine oversold and over- 26 14 3438
This \Veighted Rate of Changeindica- bought markets.This getsthe investorinto 26 15 368-l
tor wasfirst spot testedusingvarious time the market before too much of the uptend 26 16 3893
periodsfor the indicator. The data tested is missed,and gets the investor out of the 26 17
----- 4404
were weekly S&P 500 prices starting in market before losseshave been incurred 27 9 3177
January 1970to June 1995,more than 25 after a reversalin the trend.
years. Spot testing indicated that a very 27 10 3635
In conclusion, the \Veighted Rate of 27 11
short time period and very long time peri- 2969
Changeindicator hasimproved upon the 27 12 3378
odswere the leastsuccessful.As a result, SimpleRateof Change.As with nearly an! 27 13 3358
an optimization wasperformed using a other indicator, it should be usedin con- 27 14 3378
M’eighted Rate of Change from 25 to 40 junction with other indicators to improve 27 15 3855
weeks,and moving averageson eachfrom upon its success. 27 16 3957
one-third to hro thirds the rate of change 27 17 4438
Appendix A
period. For example, for the 30.weekpe- 27 18 4684
riod N’eightedRate of Change,moving av- “Overall, (simple) rate of changemust
be judged astoo erratic relative to some 28 9 3332
eragesfrom 10 periods (l/3 of 30) to 20 28 10
other indicators, suchasmoving averages. 3357
periods (2/3 of 30) were tested. A total of 28 11 2991
189 testswere performed. SeeAppendix The reasonfor this seemsto be due to over
dependenceof rate of changeon the old- 28 12 3426
B for resultsof thesetests. 28 13 3576
The resultsof thisoptimization are pro- est data. For example, for a 31~weekrate
28 14 3552
vided in the following table and graph. As of change, if price for this week wasup
28 1.3 4036
the information indicates,the \VROC out- moderately but the price 31 weeksagowas
28 16 44%
performed the SROCin the lengthy peri- rising steeply,then the rate of changecal-
28 17 443i
ods. The third column of the abovetable culation would fall sharply this week. Ob-
28 - 18
----- 4532
viously, sucha severerate of changeplunge
show the resultsof using the crossingof 29 9 3829
the zero line by the moving averageasthe would havenothing to do with the market’s
current trend. Despite that, a sell signal 29 10 3144
by/sell trigger. The results were en- 29 11 2966
hanced significantly. could be given, assumingthat the previ-
29 12 3357
ous week’srate of change calculation was
The optimum results lvere achieved 3658
usinga 34week iveighted Rate of Change only slightly positive. Thus, this depen- ;i f: 3530
with a 15weekmoving average. This com- dence on old data many explain the more 29 15 3830
bination resulted in an ending equity po- erratic behavior of the optimization curve 29 16 4712

14
MTA JOURN,V, * \\‘inter - Spring1997
 WROC Mov. Avg. Equity in WROC Mov. Avg. Equity in WROC Mov. Avg. Equity in
(weeks) (weeks) June 1995 (weeks) (weeks) June 1995 (weeks) (weeks) June 1995
29 17 4486 -- 34 -- 22 3714 39 18 3153
29 18 4108 35 11 3769 39 19 4190
-- 29 19 -- --4497 35 12 3826 39 20 3748
--
30 lo 3148 35 13 4134 39 21 3575
30 11 2993 33 13 5344 39 22 3482
30 12 3367 33 15 5410 39 23 3296
30 13 3493 ‘ii 16 4633 39 23 3842
30 14 3789 il.;, 17 3938 39 25 3656
30 13 4323 33 18 3730 39 26 3339
30 16 4801 35 19 4257 40 13 4689
30 17 4%0 35 20 4213 40 14 4792
30 18 4206 33 21 3830 40 15 3409
30 19 4465 35 22 3782 40 16 3i58
30 20 --4482 -- 35 23 -- --3617 40 17 3787
31 lo 3019 36 12 3960 40 18 4072
31 11 3078 36 13 4281 40 19 3186
31 12 3453 36 13 5307 40 20 3018
31 13 3369 36 15 4858 40 21 381i
31 14 3930 36 16 4114 40 22 3.516
31 15 4674 36 17 3857 40 23 3472
31 16 5118 36 18 3626 40 24 3770
31 17 4893 36 19 4245 40 25 3390
31 18 4427 36 20 3964 40 26 3264
31 19 4285 36 21 3675 Appendix C
31 20 4122 36 22 3641
-- The following graphs show several
32 iti 3128 36 23 35i8
stocks’ weekly price graphs. Below the
32 11 3302 36 24 3355
price graph is the \Veighted Rate of
32 12 3656 37 12 3958 Change (NXOC) indicator used in con-
32 13 3703 37 13 3597
32 14 40% junction with a 15.week moling a\-erage.
37 14 5254
32 15 4662 Buy decisions were triggered when the
37 15 4698
32 16 5003 1Sweek moving average of the \YROC
37 16 3839
32 17 4935 37 crossed abo\-e the 1 .O line. Comersely, sell
17 3864
32 18 4430 decisions were triggered when the 15-week
37 18 3977
32 19 4026 37 19 4300 mo\ing average of the I\‘ROC crossed be-
32 20 4114 37 20 3762 low the 1.0 line.
-- 32 -- 21 -- --4318 37 21 4054
33 ii 3497 37 22 3834
33 12 3638 37 23 3540
33 13 4026 37 24 -- 3310
33 14 4361 38 12 3900
33 15 5034 38 13 4946
33 16 5451 38 14 4958
33 17 4112 38 15 4665
33 18 3’793 38 16 3919
33 19 4018 38 17 3913
33 20 4250 38 18 4220
33 21 4002 38 19 425;
-- 33 22 --3920 38 20 3753
34 11 3778 38 21 3684
34 12 3843 38 22 3585
34 13 4135 38 23 3394
34 14 5186 38 24 3383
34 15 5392
34 16 5174 -- 38 -- 25 -- 3637
39 13 4992
34 17 3909 39 13 4t85
34 18 3670 39 1.5 4389
34 19 4091
39 16 3885
34 20 4230 39 li 383'7
34 21 4046

MTA JOURML * \\-inter - Spring 1997

 Kellogg Co. Corn Weekly 12/29/95 C=76.625 ,000 0=76.875 Caterpillar Inc. Corn Weekly 12/29/95 C=59.000 -1.875
H=77.375 L=76.375 V=363,100 0=60.875 H=60.875 L=58.875 V=734,000

I ! Ii

A 92 al * a

HersheyFoods Corp. Corn Weekly 12/29/95 C=65.625 t.375 Compaq Computer Corp. CornWeekly 12/29/95 C=48.750
0=65.375 H=65.625 L=64.750 V=62,500 -1.000 0=49.875 H=50.500 L=48.000 V=2,281,900
P---IF--h -- ‘---=o=sJn-L-m- -carrupe l-c=uls-~m-m”~3mm.amovea~sm
4k
I’,1
Ii’ “‘j i--

16 MTA JOURNAL l \Vinter - Spring 1W

Boeing Co. Corn Weekly 12/29/95 G77.875 t.375 0=77.500 Bellsouth Corp. CornWeekly 12/29/95 C=43.625 t1.250
H=78.625 L=77.375 V=l,O43,600 0=42.625 H=43.875 L=42.375 V=l,O64,500

Lilly Eli & Co. Corn Weekly 12/29/95 C=55.250 -.500 Amer Tel & Teleg Co. Corn Weekly 12/29/95 C=64.875 -1.125
0=55.750 H=56.500 L=55.500 V=l,651,500 0=65.875 H=66.500 L=64.500 V=2,467,400
PrrTYTIIcbwel
lllBe-m 111s
Oars75
-9m LUIDD
v.ae7m

MTA JOURILIL * \Gnter - Spring 1Wi

 Procter & Gamble Co. CornWeekly 12/29/95 C=83.125 t1.250 Glaxo Hlgs Plc Sponsored A-Weekly 12/29/95 C=28.125 t.375
0=83.875 H=84.000 i=82.125 V=971,200 0=27.625 H=28.250 L=27.625 V=943,600
*a-S. CIhm *- CalI-.I10-875HUDm
La,=VmB) P

BancOneCorp. CornWeekly 12/29/95 C=37.500 t.250

0=37.250 H=37.750 L=37.000 V=500,700
p--w-l ~-c-ama.z¶c-a7R.wrp¶L.l7morrmn.
1 Bibliography
Robert \V. Colby and Thomas A. Meyer, The Encvclone-
dia of Technical Market Indicators, NewYork, Nk;: Irwin,
Inc., 1988

Thomas 1. Hardin, CFP, CMT

Thomas Hardin is a Director and a Senior Portfolio hlan-
ager with the Portfolio Management Group division of
Smith Barney. He has been in the investment industl?
since 1977. First atJ.C. Bradford; then at Prescott, Ball &
Turbin; and in 1982 at E.F. Hutton which, through merg-
ers, became Smith Barney Tom became a portfolio man-
ager, through Hutton Portfolio Management in 198i. Mr.
Hardin began managing global balanced portfolios in 1994.
Tom is currently writing a book on international and
global investing, “The Conservative Global Investor,” due
out bv the end of 1997. He attended the Universiv of Lou-
isville and received a BS/B=2 from Skidmore College in
Saratoga Springs, NY

18 MTAJOURNAL l \\‘inter - Spring 199:

 Volume Weighted Relative Strength Index
Introduction
In this pa/w I proposr to examiw the On
Balanre lblrtm~ (OBI’) in the&lalive Stree,l,gth
Index (RTI) format, rind to rwafr n \hlutnf~
Wighted Relative StnnRfh Index (IWRSI).
The first principle that must be fully ex-
plained and understood is that an oscilla-
tor. either price or volume derived, is sub
ordinate to a basic trend analysis. “A trend
is a time measurement of the direction in
price levels covering different time spans.
There are many trends, but the three that
are most widely followed are primary, sec-
ondary, and short-term.” ’ There is no
universal law governing the time frame
which these three trends must follow.
There is a tendency for certain time peri-
ods to be more common than others:
“Dow Theory for example, classifies the
primary trend as being in effect for longer
than a year. Dow defined the intermedi-
ate, or secondary, trend as three weeks to
many months. The short-term trend is usu-
ally defined as anything less than two or
three weeks. Each trend becomes a por-
tion of its next larger trend.” ’
M71en securities or markets are trend-
ing, trendlines and moving averages are
valuable tools to trade with. Ll%en a side-
ways environment develops, the technician
must resort to another tool, in order to
detect sudden changes in direction. Side-
wavs movements occur more often than
technicians like: “research indicates that
markets generally move in trading ranges
and trend less frequently” ’ It is in this
instance that the oscillator is very helpful.
An oscillator measures the rate of
change of prices as opposed to the actual
price levels themselves. M%en first discov-
ered, oscillators appear to be a magical
device to the noyice technician. The more
experience the technician gains with os-
cillators, the less likely it becomes that os-
cillators appear infallible.
In this paper, the oscillator being ex-
amined is the Relative Strength Index
(RSI), originally created bp \Yelles J.
\Yilder.
RSI= 100- 100
1tRS
RS= Averageofupcloses
overx days
Average
ofdowncloses
overx days
RussellR. Minor. CMT
M’here “RS is the ratio of the exponen-
tiall! smoothed moving average of n- peri-
ods gains divided by the absolute value
(i.e., ignoring sign) of the exponentiall!
smoothed moving average of n- period
losses.” ’ The RSI is then plotted on a ver-
tical scale from zero to one hmidred. As
originally defined (11 days for n), move-
ments of the RSI above 70 are considered
to be overbought, and movements below
30 identify an oversold condition. It usu-
ally pays to wait for the RSI to exit or enter
the overbought/oversold region. “Xn!
strong trend, either up or down, usuall!
produces an extreme oscillator reading
before too long. In such cases, claims that
a market is overbought or oversold are
usually premature, and can lead to an earl!-
exit from a profitable trend. In strong
uptrends, overbought markets can sta!
overbought for some time. Just because
the oscillator has moved into the upper
region is not enough to liquidate a long
position (or, heaven forbid, short into the
strong uptrend) .” ’
1blume holds additional information
that must be watched closely; price and I-ol-
ume are two important pieces of the tech-
nical puzzle. “First, the matter of volume.
It is always to be watched as a vital part of
the total picture. The chart trading activ-
itv makes a pattern just as does the chart
piice changes.” ’ It is believed by some
(not all) technicians, that the internal
strength of the market or a stock is mani-
fested in volume first, then in price; in
other words, volume leads price. The fact
that some technicians have this belief led
me to examine whether a volume derived
oscillator provides any better signals than
a price derived oscillator. The Relative
Strength Index is a price based oscillator.
Formulating The Volume
Weighted Relative Strength
Index
The format used was On Balance \‘ol-
ume (OBY) in the RSI formula, produc-
ing a \‘olume 12’eighted Relative Strength
Index. Joseph Granville’s OB\’ is defined
as:
OBV = [ (C- Cp) *V 1 The \7\XSI is then plotted on a verti-
[ (IC-CPO 1 cal scale from zero to one hundred. J. J.
MTA JOUIWti l \\‘inter - Spring 1997
Z is the current period’s closing price.
Zp is the previous period’s closing price.
C-Cpl is the absolute vAue of the differ-
ence between the two closing prices.
b7is the current period’s volume.
“The total volume for each clay is as-
;igned a plus or minus value depending
m whether prices close higher or lower
for that day. X higher close causes the vol-
time for that day to be given a plus value,
bvhile a lover close counts for negative
value. X running cumulative total is then
maintained b? adding or subtracting each
day’s volume based on the direction of the
market close.” ’ The level of the OB\’ line
is not important, rather the direction of
the OB\’ line itself. The theory behind
the OBY line is that volume activity should
be directly proportional to price. 11%en
divergence develops between price and
volume, the technician should regard this
as a warning signal of a possible change in
trend. “\hlume usually goes \\-ith trend;
i.e., volume advances with a rising trend
of prices and falls \\ith a declining one.
This is a normal relationship, and anything
which diverges from this characteristic
should be considered a warning sign that
the pre\-ailing trend may be in the process
of reversing.” ’
Divergence occurs when the price chart
makes a new high or low that is not accom-
panied by a new high or low in the oscilla-
tor. The concept of divergence is the ba-
sis of the Dow Theory. “The movements
of both the railroad and industrial stock
averages should always be considered to-
gether. The movement of one price aver-
age must be confirmed by the other be-
fore reliable inferences may be confirmed.
Conclusiom based on the movement of
one average, unconfirmed by the other,
are almost certain to prove misleading.” ”
The formula for the \hlume LYeighted
Relative Strength Index (\11XSI) is
VWRSI
= 100- 100
1t VWRS
VWRS
= Average
ofupOBVx days
Average
ofdown
OBVXdays
hlurphl- outlines the three most useful
qualities of an oscillator: “when the oscil- Criteria Contintued U.S. Steel Group
lator reaches an extreme, when it diverges
from price, and when it crosses the neu- (See Tables l-6) March 16,199O to June 14,1996
tral line if present.” “’ All tests were conducted net of commis- PercentageReturn Per Trade
sions for every criteria. At a glance Tables for EachGivenCriteria(Weekly)
Testing 1 through 6 yielded ambiguous and incon-
sistent results. I decided to isolate one RSI VWRSI
In order for an oscillator to be valuable, A. Movements
crossing
above70,under
30 45.1 5.3
study (T.S. Steel) wave by wave, for each
it should be applicable in more than one scenario studied on a daily and week]: ba- 170overbought.
30oversold)
9 days
situation. The \WXSI was tested against sis. Each case was analyzed on a percent-
the RSI on a daily basis over a two-year B.Movements
crossing
above70,under30 0.0 -11.3
age return per trade. I offer the results of (70overbought,
30oversold)
14days
period and for a six-year period on a
this analysis in two IvaTs, firstl: the tables
weekly basis. The original 11 day period C Movements
crossing
above
80.under20 0.0 -3.1
below, and second in graph form (page
was used for both the RSI and \7’1XSI. This 21). Finally I compared cumulative aver- 180overbought,
20oversold)
14days
was then compared to a 9 day period. RI. age percentage returns for all three cases 0 Movements
crossingabove
80.under20 0.0 0.0
Chaiken found that a 9day period is more
studied daily and weekly (pages 22-23). (80overbought.
20oversold)
9 days
effective in trading stocks. “For trading
stocks, I found that a g-day RSI is much E. Movementscrossingaboveandunder50 -5.6 0.17
U.S. Steel Group (50represents
theneutralline)9 days
more effective with the 30’and i0 break
points for trading.” ” Swings are wider on July 18,1994 to June 14,1996
PercentageReturn Per Trade F. Movements
crossingabove
andunder50 -0.72 -0.53
a g-day formula; and some technicians em- (50represents
theneutral
line)14days
ploy 80.20 in place of the 70,30 values. for EachGivenCriteria(Daily)
G. Movements
exiting
70andentering
30 26.44 2.5
RSI VWRSI (70overbought,
30oversold)
9 days
IThat Was Tested A. Movements
crossingabove
70 under30 48.5 135
X - U.S.SteelGroup (70overbought.
30oversold)
9 days H. Movements
exiting
70andentering
30 44.5 -16.0
(70overbought.
30oversold)
14days
GKM- GreatLake Minerals(junior B. Movements
crossing
above
70,under30 41.2 -5.7
Canadianminingstock) (70overbou(ht,
30oversold)
14days I Movements
exiting
80andentering
20 0.0 -17.0
(80overbought,
20oversold)
9 days
DWU - Dow Jones Utility Index C. Movements
crowngabove
80,under20 97.3 54.4
(80overbought.
20oversold)
14days J. Movements
exiting
80andentering
20 0.0 -2.0
(80overbought.
20oversold]
14days
Criteria for Testing D. Movements
crossingabove
80.under20 0.0 0.0
A. Movementscrossingabove70.under30(70overbought,
30 (80overbought.
20oversold)
9 days
oversold)
9 days
E. Movementscrossingaboveandunder50 -2.24 -2.5
B. Movementscrossingabove
70,under30(70overbought.
30 (50represents
theneutralline)9 days
oversold)
14days
F Movementscrossingaboveandunder50 -0.72 -0.53
C. Movementscrossingabove80,under20(80overbought,
20 (50represents
theneutral
line)14days
oversold)
14days
G. Movements
exiting
70andentering
30 266 10.125
0. Movementscrossingabove80.under20(SOoverbought.
20 (70overbought.
30oversold)
9 days
oversold)
9 days
H. Movements
exiting
70andentering
30 45.1 78.0
E. Movementscrossingaboveandunder50(50represents
the (70overbought,
30oversold)
14days
neutral
line]9 days
I Movements
exiting
80andentering
20 23.25 45.3
F. Movementscrossingabove
andunder50(50represents
the (80overbought,
20oversold)
9days
neutral
line)14days
J. Movements
exiting
80andentering
20 0.0 0.0
G. Movements exiting
70andentering
30(70overbought.
30over- (80overbought,
20oversold)
14days
sold)9 days
H. Movementsexiting
7Oand
entering
30(70overbought,
30over-
sold)14days
I. Movements exiting
80andentering
20(80overbought.
20over-
sold)9 days
J. Movementsexiting
8Oand
entering
20(80overbought,
2Oover-
sold)14days

MTA JOURhX l \\‘inter - Spring 1997

Graph 1 U.S. Steel Group (Daily Return) Graph3 DailyCumulative
AveragePercentage
Returns
July 18,1994 -June 14,1996
100

75

I I I I
-100 ’
I I I I I I I I I I
-25 RSI 9 RSI 14 VWRSI 9 VWRSI 14
A B C D E F G H I J RSINWSI
Criteria Graph4
Graph 2 WeeklyCumulative
AveragePercentage
Return
U.S. Steel (Weekly Return) 600
March 16,1990-June 14,1996
60
500

400
q

1
RSI
E
n VWRSI oz
8
s

br-r
z 200
$
100

.
I n
0

g 300f I I I I
-100 ’
RSI 9 RSI 14 VWRSI 9 VWRSI 14
I I I I I I I I I
RSINWRSI
A B C D E F G H I J
Criteria
Conclusion
Cumulative Averaged Percentage Return The value of the \%RSI is that it is volume derived. \‘olume
RSI vs. \%%I provides additional information not found in a price-derived os-
cillator. The empirical data provided on graph 1 illustrate that
Stock RSI VWRSI the \‘M’RSI wassuperior to the RSI in certain casesstudied on a
daily basis.In the weekly data, the RSI proved superior and gen-
Symbol 9 14 9 14 erated lower losses,illustrated on graph 2. Taking a cumulative
X Daily 244.6 104.6 13.2 25.23 averageof all the signalsstudiedfor both RSI & \%XSI (graphs3
& 4), the 1WRSI outperformed the RSI on both a weekly and
Weekly 216.20 -1.6 -7.0 -23.4 daily basis,for the 14day time period studied.
DWU Daily 15.0 12.4 10.28 24.6 I feel that this evidence substantiatesthe fact that a volume
derived oscillator will enhance a price derived oscillator. Simul-
Weekly 41.8 -9.4 35.2 90.6 taneousvolume and price oscillator divergence from the price
GKM Daily 11.20 -47.44 42.6 1.0 chart itself shouldbe stronglyheeded. No oscillatorsignalshould
be acted on without respectfor the underlying trend. The actual
Weekly 550.2 28.00 35.20 118.0 inception and application of the 1’MXSI can be followed on pages
22-23.

MTA JOURNAL l Winter- Spring1997

 X-N Daily 11/22/96 U.S. Steel (X) Daily Results
C=30.250 t.125 Mov Avg 2 lines 29.796 28.476
From July 18, 1994 to June 14, 1996
xo*lY llm% c=xl.zso
.. 25YnrA-49
Zlhcs23.79~l8.476 1
Table 1
Returnon100
TimePeriod #ofTrades Shares
Traded
VWRSI
Signals ofOscillator RSI VWRSI RSI VWRSI
Buy&Cover Shod<30 9 12 7 583 95
SellaSellShort
>70
BUYa cOVHshort<30 14 7 a 289 -40
SellaSellShob
>70
Buya COWShOri<20 9 3 5 292 272
seii a seiishort>a0
BUYa COVH ShOft<2O 14 0 1 0 685
sd a sd short>a0
BUYa cOVHshort>5o 9 29 26 -65 -66
SellaSellShort
<50
BUYa COVH short>5O 14 51 41 -37 -22
Sell&SellShort
<50
CoverShorr&BIJ~b”Jssin[lAbe 30 12 a -320 81
Eelcllv
Sel!ShortCrcssino 79
CoverShortSBuyCxsin[lAbov!38 6 6 271 47
SellShort
Cmsinc ?e:rjw
70
CoveiShort&B~jy Cms’xAbove 20 4 6 93 272
Sel’Shrjri
bossing Eelaw80
3~ Short 5,E?yCrossimAbove 20 0 2 0 0
stii shO:lcrOSS!nO
BdOW80

U.S. Steel (X) Weekly Results

X-N Weekly 1l/22/96
C=30.250 t.500 Mov Avg2 lines 28.281 27.642 FromMarch16, 1990to June14, 1996
Table 2
Return
on100
TimePeriod # ofTrades Shares
Traded
VWRSI
Signals ofOscillator RSI VWRSI RSI VWRSI
BUY& COVH short<3o 9 12 7 406 16
Sella SellShort>70
BUYa COVH shOIi<3o 14 7 a 0 -34
Sell&SellShort>70
BUY& COVH short<2o 9 3 5 0 -31
St31a seii short>a0
BUY& cOVHshort<2o 14 0 1 0 0
Sell&SellShort
>80
BUY& cOVHshod>5o 9 29 26 -13 4
Sell&SellShort
<50
BUY& COVH
shOti>5o 14 51 41 -97 -49
Sell&SellShort
<50
CM Shgrt &BUY Crossino
Abe 30 12 a 238 lo
SellShrJrt Below
Crrjssino 70
CoverShort&BuyCmssinaAbove
30 6 6 89 -32
SellShor!
CmssinciBelow
10
CoverShod&EuyCrossincAbove
20 4 6 0 -34
SellShrjri
Crossin!:
Beiow
ac
CoverShrJrt
&BuyCmsino Above
20 0 2 0 -2
SellShc;rt
Cmsincl Belr~w
80

22 MTA JOLXML l \Vinter Spring 1995

 Dow Jones Utilities (DWU)Daily Results Great lake Minerals (GKM) Daily Results
From July 18, 1994 to June 14, 1996 From July 18, 1994 to June 14, 1996
Table3 Table5
Returnon100 Returnon100
TimePeriod # of Trades SharesTraded TimePeriod # ofTrades SharesTraded
VWRSISignals of Oscillator RSI VWRSI RSI VWRSI VWRSISignals 01Oscillator RSI VWRSI RSI VWRSI
Buy&Cover Shrjrt
<30 9 8 3 -27 -29 5uy&Cover Short
<30 9 3 6 14 111
St/l&SellShort
>70 Sell5(SellShort
>70
Buy&Cover ShrJrt
<30 14 7 3 -32 -75 Buy&CM ShrJrt <30 14 3 21 -69 75
Sell&SellShrJrt
>70 Sell&SellShort>70
Buy&Covsr Shari
<2O 9 0 0 0 0 Buy&her Short <2C 9 1 6 100 154
Sell&SellShari
>8C Seil&SeliShrrt>80
Buy&Cover Short
<iO 14 0 0 0 0 Buy&CoveiShort <iO 14 0 2 0 -38
Sell&SellShoi:
>80 Sell&SellShrJit
>a0
Buy5,Cover Short
>50 9 32 45 118 100 BuySCover Short
>50 9 48 17 -99 -88
Se1
15,SellShort
<50 &ii &SellShort~50
Buy&Cm ShrJrt >50 14 43 77 109 -58 Buy&Cover Short>50 14 57 18 -76 -2
Sell&SellShoit
<50 Sell5,SellShl;it
<50
CoverShrjrt
&BuyCmsinc Above
30 9 8 4 -56 -37 Cover Short&BuyCrrJssinO
Abr~ve
30 9 3 7 12 9
StllShort
Ciossino
BS/OW70 SellShrJrt
Cmsino Below73
CoverShort&BuyCrossino
Atme30 14 2 1 -49 5 Cover Short&BuybssinoAbove 30 14 1 7 -81 15
SellShrjrt
CmsimBelow 70 Sel!ShutCmsino %irjw!O
CowShort &BuyCrossino
Above
20 9 1 1 40 5 CoverShort& BUYCrrJssinO
Above
20 9 1 7 -83 27
SellShrJrt
Cmsino Below
80 SellShrjrt
Cmsinq Belsw80
CoverShort&BuyCmsino Above
20 14 1 1 34 5 Cover Short& BuyCrossincl
Above
20 14 1 3 0 -45
SellShort
CrrJssinO
Below
80 SellShort
Cmsina Below80
Dow Jones Utilities (DWU)Weekly Results Great lake Minerals (GKM) Weekly Results
From March 16, 1990 to June 14, 1996 From March 16,199O to June 14,1996
Table4 Table6
Returnon 100 Returnon 100
TimePeriod # of Trades SharesTraded TimePeriod # of Trades SharesTraded
VWRSISignals of Oscillator RSI VWRSI RSI VWRSI VWRSISignals 01Oscillator RSI VWRSI RSI VWRSI
Buy&Crjver Short
<30 9 9 2 -16 52 BuySCover Short
<30 9 3 4 -29 -89
Sell&SellShort>70 Sell&SellShrJ:t
>7C
Buy5,Cover Short
<30 14 3 4 -39 126 Buy&SowShrJrt <30 14 12 4 -4 -63
Seli&SellShort>70 Sell5,SellShort
>70
Buy&Cover Short
<iO 9 0 0 0 0 auy5,Cover Shrjrt
<20 9 1 1 100 -3
SPII&SellShort>80 Sell&SE/IShort>a0
Buy&Cover Short
<20 14 0 0 0 0 Buy&Cover Short
<20 14 1 1 78 -3
Sella,SellShort
>80 Sell&SellShut>80
Buy&CDVF~ Short
>50 9 24 4 -13 32 Buy&Cover Short
>50 9 18 11 188 383
Seil&SellShort~50 Sell&SellShrJrt
<50
Buy5,CciverShrJrt
>50 14 39 37 -97 271 Buy&Cover SM >50 14 33 22 6 271
Sell&SellShrjrt
<50 Sell&SellShrjrt
<50
CoverShut&BuyCmsind Above
30 9 9 3 238 58 Cover Short5,BuyC:rJssinti
Above30 9 4 5 -19 -77
SellShort
CrrjssinQ
Below70 SellShort
!Mng Be!ow 70
CoverShort 5,BuyCrrjssinC
Above
30 14 2 3 a9 453 Cover ShrJrt
&BuyCrossina
Above30 14 2 2 -27 5
SellShrJrt
Cmsino Bela70 SillShort
CrossinaB&w70
CoverShoit &BuyCrossinoAbove
2C 9 0 1 0 34 Cover Short& BuyCmssincl
Above20 9 2 2 16 21
SellShrJrt
CrossinaBelr~w
80 SellShrJrt
CrossirxBelow
80
CoverShort SBuyQossino Above
20 14 0 0 0 0 Cover Short& BuyCrossincl
Above20 14 2 2 135 13
SellShvtCrossinoBelow80 SellShrJrt
CrossinaBEIOW
80

MTA JOURNAL * \Vinter - Spring 1W 23


Footnotes
1. Jhtin J. Pring, Technical dnalmis Ex-
plained: Third Edition (LW ,UcGrazv Hill
Inc., 1991),p.13.
2. Joh~zJ Murphy, Technicaldnal~sis of The
Futures Markets (A?: LVew krk Institute
of Finance, 19911, p.36.
3. Thomas R. De&lark, The Xew Science of
Technical Analysis (‘VK John 1171eJ &s
Sons. Inc., 1994), p. 129.
4. Robert II: Colby and Thomas d. Jlqers,
The Enqyclobed~a Of Technical Jlarket In-
dicators (;W’: Richard D. Irwin, Inc.,
1988), p. 43.
5. John J. Murphy, TechnicalA-inalrsis of The
Futures Markets (?LY: .\‘plv York Institute
of Finance, 199I), p. 300.
6. Robert D. Edzvards andJohn Xlagee,x-
nical Analysis of Stocks: Xezv Enhanced
Edition (Boston, MA: International Tech-
nical .ina[ysis Publishers, 1991) p.51.
7. John J. i\furphJ, Technicaliinalwis of The
Futures Markets (AT: Aka York Institute
of Finance, 19911, p. 185.
8. John J. Murphy, Technical Analyis of The
Futures Markets (.X77 LpUl York Institute
of Finance, 1991), p. 300.
9. Robert Rhea, The Dow Theoq (Burlington,
lT: Fraser Publishing, 19931, p. 14.
10. John J. Jluqbh~, Technicaliinalwis of The
Futures Markets (XY: NW York Institute
of Finance, 1991), p. 277.
11. Marc Chaiken, Technical dnalyis of Stocks
CG Commodities Magarine: Januaq 1994
(Seattle, \\A), p.24.
Bibliography
1. Robert M’. Colby and Thomas A.
Mever, The EncvcloDediaof Technical
Market Indicators, New York, NY,
Irwin, Inc., 1988.
2. ThomasR. DeMark, The New Science
of Technical Anahais, New York, AY,
John \Viley & Sons.Inc., 1994.
3. Robert D. Edwardsand John Magee,
Technical Analvsisof Stocks:New En-
hanced Edition, Boston, MA, Interna-
tional Technical Analysis Publishers,
1991.
4. Joseph Granville, StrateFr of Daily
Stock Market Timing, SJ, Prentice-
Hall, EnglewoodCliffs, 1960.
5. John J. Murphy, Technical Analysisof
The Futures hlarkets, New York, NY
Institute of Finance, 1986.
24
5. John J. Murphy, Intermarket Techni-
cal Analvsis, W, John iriley &: Sons,
Inc., 1991.
7. hlartin J. Pring, Technical Analysis
Explained. Third Edition, NY,
RlcGraw-Hill, 1991.
9. Robert Rhea, The Dow Theory,
Burlington, \T, Fraser Publishing,
1993.
9. RussellRichard, The Dow Theov To-
dal; Burlington, \T, FraserPublishing,
1981.
10.Jack D. Schwager,The Market IVizards,
hY, New York Institute of Finance,
1989.
Periodicals
1. Technical Analvsis of Stocks & Com-
modities,TechnicalAnalysisInc., 4’i5i
California Ave. S.\\‘., Seattle, ‘I\‘A
9811&4499,January 1994.
2. Technical Analysis of Stocks & Com-
moditiesMarket Timing, 2nd Edition,
\‘olume 6, Technical Analysis, Inc.,
3517 S.1V. Alaska St., Seattle, LVA
98126-2700.
Software
1. Supercharts: Omega Research2.1,
Miami, FL, 33513.
Russell Ft. Minor, CMT
For the past four years, Russell
hlinor hasbeenan institutional equit7,
trader at RBC Dominion Securitiesin
Toronto. Prior to that, he wasan in-
stitutional equity salesmanat BBN
JamesCapel,a researchboutique. He
started in the investment businessas
a retail salesmanafter receiving an
economicsdegreefrom York Uniter-
sity Downsdew,Ontario. His first ex-
posure to technical analyisoccurred
when he wasa retail salesman.
MTA JOURNAL 0 \j7inter- Spring1997
 Dividends Matter. Does Anyone Care?
GregoryJ. Roden

“They say I’m crazy, got no
sense, but I don’t care.“’
From year end 1925 to year end 1995,
the DowJonesIndustrial Average (hereaf-
ter DJIA) increased from 156.66 to
5117.12, a mean rate of appreciation of
5.29% per year. The rate of appreciation
in the DJW iswell below the 10%total re-
turn for the DJIA during the sameperiod
becausethe index does not include rein-
vesting of dividendsasdo the total return
figures. Given that dividendsand their re-
investment provide half of equities total
return, it could be argued that low divi-
dend yields in and of themselveswill re-
duce future stock total returns ‘?and, like-
wise,high dividend yieldswill increasefu-
ture stock total returns. This paper will
first explore and quantify the relationship
between dividend yields and subsequent
total ratesof return. Then the author will
then ponder this relationship in light of
the current low dividend yield and will
speculateasto whenthe historicalrelation-
some very long-term market tops which, relation, which is confirmed by the di\i-
after the ensuing corrections, it took years dend yield and 1j-year rates of return hay-
for the market to exceed. For example, it ing a correlation coefficient of ,715. M?th
took 25 years after the 1929
top and nine years after the 0.10- Fifteen Year Real-Total Rate of Return
1973 top for the DJIA to 0.14 .’
reach a new high. These 0.12..
markets encompassed 0.1..
some horrific corrections 0.m..
that shook the confidence 0.00I’
of buv-and-hold investors of 0.04..
the &me. As measured 0.02
” --
from the top to bottom, the
1929market lost89.2%and -W
the 1973market 45.1%.
Though bull and bear
market movesare both randomly accom- the correlation coefficient having a pos-
panied by low and high dividend yields, siblerangefrom -1 to tl, the measurement
secularbear marketsdo tend to follow low here of ,715 representsa good, positive
dividend vields. The two charts below il- correlation. Another measureof correla-
lustrate &is tendency The top chart rep- tion is r?(RSQ, which hasa possiblerange
resentsthe dividend yield on the S&P500 of 0 to 1. The 15.yearratesof return and
at the quarter end from 1926through the the dividend yields have an r? of ,526.
fourth quarter of 1980. The bottom chart
is the annualizedrate of return (dividends Holding Period Correlation

!
ship will come to fruition. reinvestedand returns inflation-adjusted) Holding
In addition to its direct effect on the for the 15-yearholding period subsequent Periods RSQ Correl Std Dev
total return, the Dividend Yield is widel) to the indicated quarter, e.g. for the fourth
1 Yr. 0.106 0.325 0.245
quoted asbeing a meansof measuringthe quarter of 1980the time period is 12/31/
2 Yrs. 0.152 0.415 0.154
value in the market on a historical basis. 80- 12/31/95.” The similaritiesof the hvo 3 Yrs. 0.216 0.464 0.115
Low dividend yields have accompanied charts is indicative of a correlation be-
4 Yrs. 0.290 0.538 0.094
tween dividend
5 Yrs 0.313 0.561 0.080
--i yield and subse- 0.539 0.070
6 Ii-s. 0.290
Dividend Yiiid quent rate of re-
7 Yrs. 0.308 0.555 0.063
turn.
8 S-s. 0.346 0.588 0.059
To further ex-
9 Yrs. 0.331 0.576 0.056
plore this possible
10 Yrs. 0.334 0.578 0.054
correlation, the 15-
15 E-s. 0.526 0.715 0.045
year ratesof return
20 Yrs. 0.508 0.709 0.036
are matched with
25 Yrs. 0.501 0.703 0.027
the dividend yield
30 Yrs. 0.409 0.640 0.019
for the initial quar-
ter, which yieldsthe The above table examinesthe correla-
scatter diagram tion for several other holding periods.
above. With the There is a generalincreasein the correla-
wide distribution of tion numbers as the holding period in-
0.14 returns on this scat- creases,up to 15years. As it turns out, the
0.12 ter diagram, it is Is-year time period hasthe highestcorre-
0.1
obviousthat the re- lation of the holding periods examined,
0.m
lationship is not a asmeasuredbv r2 and the correlation co-
0.0
strict linear one. efficient. At &e sametime, there isa sub
0.04

0.02 The general up- stantialdecreasein the standarddeviation

0 ward slope of this of the returns for the respectiveholding
4.02 chart again indi- periods. Then, after 15years,the correla-
catesa positive cor- tions begin to decreaseeven though the

MTA JOURNIL l SVinter- Spring1997 25

standard deviations are also continuing to
decrease.
The question as to how “good” a corre-
lation has been demonstrated bv r’) and the
correlation coefficient is subjective as said
measures of correlation are biased towards
straight linear relationships. Consider the
chart below a hypothetical relationship be-
tween dividend yield and the rates of re-
turn for a fictional holding period. The
straight line on the chart depicts a linear
relationship wherein the rate of return in-
creases 0.02 % for each one percentage
point increase in the dividend TieId. This
straight line relationship has a perfect cor-
relation with an r‘? and a correlation coef-
ficient both equal to 1. Unfortunately the
relationship is of no significance as the
Geometric Funclim
\ the dependent variable. Ac-
return figures scarcely increase. The
minute changes in the return numbers can
be measured by the standard deviation of
said numbers, which is a minuscule ,003.
The curved line on the chart represents
a geometric relationship between the divi-
dend yield and another hypothetical hold-
ing period with the total return going up
geometrically as the dividend yield in-
creases. Although this geometric relation-
ship is obviously more significant than the
linear relationship, its r9 is .793 and its cor-
relation coefficient is ,890, not a perfect
linear relationship. The geometric rela-
tionship has a standard deviation for the
return numbers of ,307, a much more vola-
tile group of numbers than the linear ones.
The moral of the story is that rp
and the correlation coefficient
alone are not enough to judge the 0.12
: viations for all the time periods
significance of a statistical rela- 0.1..
tionship. So, including the Stan- i
dard deviation of the return num- * o.m.-
bers in this analysis is helpful to s o,m__
gauge the significance of the re- 1
lationship. j oB4‘.
Considering the foregoing, 1~O.OZ
the decreases in the holding pe-
riod correlation numbers after 15
years, even as the standard devia-
tions continue to decline, take on in-
creased significance. An explanation
could be that valuations might have a 30-
year cycle, with 15 years from crest to
trough. ’ Thereby after 15 years valuations
start to turn into the next cycle. This
would result in a decline in the correla-
tions behveen dividend yield an rates of
return after 15 years even as the standard
deviations decrease.
M’ith this in mind, an investor with a
l+ear time frame would want to ascertain
what rate of return he could expect over
the next 15 years given the prevailing divi-
dend yield. In order to so quantib this
relationship, it will be necessary to take
some sort of average of the various plots
on the previous scatter diagram.
For this study the dividend
yield prevailing at the end of
each quarter will be the inde-
pendent variable and the sub-
sequent ISyear rate of return
cordingly the rates of return
will then be sorted according
to the corresponding diri-
dend yield. Then the geomet-
ric mean of the 15~vear rates
of return will be calculated for
7 0 ’ those rates of return that cor-
respond to similar dividend
yields; in other words, the 15-vear scatter
diagram will be segmented along the X
axis and the mean of the Y values in each
segment will be calculated. The X axis will
be segmented by grouping the dividend
yields as follows: less than or equal to 3%;
greater than 3% and less than or equal to
3.5%; greater than 3.5% and less than or
equal to 4%; greater than 4% and less than
or equal to 4.5%; greater then 4.5% and
less than or equal to 5%; greater than 5%
and less than or equal to 6%; greater than
6% and less than or equal to 7%; and
greater than 7%, designated as 8% on the
chart below.
The resulting values on the chart are
the mean real total rate of returns for eq-
Total Return Expectation
Finsen Year HoMii Period
/+---
MTA JOURN~IL * \Cinter - Spring 1997
uiF investments made at a calendar quar-
ter end, having a ISyear holding period,
with the dividend yield at the quarter end
within the segmented dividend yield
range. Based on the market experience
since 1926, these values are what investors
Gth a ISyear holding period could expect
to receive in the future for an annual re-
turn at a given dividend yield. Hereinaf-
ter, these values will be rkferred to as the
Total Return Expectation. 3
This Total Return Expectation as it
might involve overlapping of time periods
or totally different time periods is not a
historical measure of market return in the
usual sense. Rather, it is the mean return
received during similar conditions as de-
termined bv the dividend yield at the start
of the holding period and is what inves-
tors might thereby expect in the future
under similar conditions, i.e. similar divi-
dend yields.
The Total Return Expectation makes
use of the geometric mean which provides
a truer indication of what the “average”
rate of return would be than what might
be expected from looking at a scatter dia-
gram. For example, if a given dividend
yield had only hco corresponding values
of t.50 and -.~0, a casual observer might
conclude that these hvo observations av-
erage out to 0.0. But that would not be
the actual result because rates of return
are compounded. Consequently, if a port-
folio has a 50% gain one J-ear and a 50%
loss the next year (or visa versa) the net
result is a 25% loss ol-er two years
(1.5*0.5=0.75).
Scatter diagrams for other time periods
can similarly be brought into focus using
this same Total Return Expectation meth-
odology The table at the top of the fol-
lowing page enumerates the Total Return
Expectations for various holding periods.
This Expectation method has yielded
some surprising results; first consider that
the 5-year time frame now has the highest
correlation. Note also that all the correla-
tion numbers hare increased and the stan-
dard deviations decreased. This
) is because rather than measuring
the correlation and standard de-
corresponding to a given dividend
yield, the Total Return Expecta-
tion instead measures the mean of
all the time periods correspond-
ing to a given dividend yield.
l’he correlation numbers in-
crease substantially from the l-
year to the P-Tear holding period,
but then remain fairlv constant
 vides a much better indication of future
Total Return Expectations
performance.
Yield 3.0 3.5 4.0 4.5 5.0 6.0 7.0 8.0 RSQ Correl Std.Dev. The same sort of comparison can be
1 Yr. -1.4% 3.1% 4.2% 8.6% 8.8% 10.1% 1.7% 37.8% 0.51‘4 oxi 0.122 done for the j-year holding periods; the
2 Yrs. -1.6 2.3 2.9 4.4 9.9 13.0 10.9 23.4 0.893 0.943 O.OT9 j-year Expectation prediction and the 5-
3 Yrs. 1.6 1.5 3.5 3.7 7.2 13.2 11.4 20.1 0.920 0.959 0.066 year trailing average can be compared to
4 Yrs. 2.6 2.5 2.8 3.7 5.8 10.5 12.3 21.4 0.907 0.952 0.067 the subsequent 5-year return. The winner
5 Yrs. 0.i 3.0 4.2 3.9 6.6 9.2 15.2 16.3 0.969 0.984 0.058 is the Expectation method with an rl’ of
6 Yrs. 0.0 2.8 4.0 3.7 8.5 9.0 13.3 13.2 0.944 0.9il 0.048 ,339 and a correlation coefficient of ,582.
7 Yrs. 1.2 2.3 4.6 5.9 8.4 10.1 ll.\?l 12.4 0.941 0.970 0.042 The j-year trailing average has a no corre-
8 Yrs. l.i 1.6 4.5 6.0 83 10.4 10.6 12.i 0.921 0.960 0.042 lation with the subsequent j-year rate of
9 Trs. -0.6 1.7 3.4 6.6 93 10.1 10.1 10.9 0.78 0.882 0.043 return with an ri’ of .005 and a correlation
10 Yrs. -0.8 1.4 6.0 6.6 9.1 10.1 10.7 10.3 o.i.i3 0.868 0.043 coefficient of -.068. It is worth noting that
15 Yrs. 1.4 1.5 5.1 .5.8 8.8 9.2 11.6 10.8 0.858 0.927 0.040 the standard deviation of the 5-year subse-
20Yrs. 2.4 3.2 5.3 5.8 8.8 8.8 9.9 10.3 0.869 0.932 0.031 quent returns was .0754, considerabl)
25 Yrs. 3.9 4.1 3.4 6.1 8.6 i.i 8.i 9.9 0.860 0.930 0.023 higher than the 15-year returns of .0383.
30 E’rs. 4.5 5.2 6.1 6.7 7.3 7.3 7.6 9.2 0.886 0.941 0.015 In light of the large variance in the j-year
returns, the Expectation method’s corre-
through the 30-year holding period. The be made between the annual return pre- lation numbers take on greater signifi-
standard deviation numbers of the Total dicted by the Expectation based on the cance.
Return Expectations drop significantl? prevailing dividend at the end of a calen- The Expectation method compares fa-
from the l-year holding period through dar quarter and the actual market return vorabl? with trailing averages of equal
the &year holding period. Then, they re- subsequent to that quarter. The first such holding periods, but how about against the
main fairlv constant through the 15-year comparison will use the 15-year holding total real “return since 1926?’ To make
holding pkriod, after which they resume period returns. Also, a comparison will be this comparison, the return since 1926
decreasing. That is to say, the Total Re- made using a common benchmark, the through every quarter from 1950 to the
turn Expectation numbers for a l-year trailing average market return, and how last quarter of 1995 will first be calculated.
holding period show a large difference well it predicted the subsequent perfor- Then, the l+ear and j-year subsequent
from the smallest expected return at a mance of the market. Specifically the trail- return will be compared to the “return
yield of 3 to the highest expected return ing l+ear average return at the end of a since 1926” for the starting quarter. The
at a yield of 8. This difference decreases calendar quarter will also be compared to results: the l+ear subsequent return and
through the &year holding period. Then the subsequent 15-vear annual return, as the “return since 1926” ha\-e an r’) of .691
this difference remains significant and illustrated in the &art below. (not bad), but a correlation coefficient of
relatively constant through the 15-year An analysis of the l+ear holding pe- -.831 (bad); the five year subsequent re-
holding period. After the 15-year holding riod comparison reveals that the Expecta- turn and the “return since 1926” have an
period, the difference narrows. Again, this tion method and the subsequent returns r’) of ,437 (not bad again), but a correla-
is indicative of a 30-year cvcle in valuations. tion coefficient of
In today’s mark&, in&stors are told not FIFTEEN YEAR HOLDING PERIOD -.668 (bad again).
to worry about valuations and corrections, At the risk of
rather to invest for the long-term. This “beating a dead
study of Total Return Expectation illus- horse,” one final
trates that the “long-term” might end up comparison was
being a “bridge too far” for maw inves- made of the “re-
tors. This mav be so because at a dividend turn since 1926”
yield 3% or less it is not until the 20-year and the l-!-ear sub-
holding period that the expected rate of sequent return.
return is greater than 2.2% annually which The comparison
is approximatelv equal to the inflation ad- turned in an rl’ of
justed rate of r&turn for U.S. intermedi- .021 and a correla-
ate government bonds. li tion coefficient of
Investors with a holding period less have an I-’ of ,839 and a correlation coeffl- -. 143. L\‘hereas,
than 30 years at this dividend yield who cient of .916. The trailing average has a comparing the l-year subsequent return
expect td earn the historical average are weak correlation with the subsequent rate to the l-year Expectations yields an r’) of
probably in for some disappointment. of return with an r? of ,312; unfortunately, .075 and a correlation coefficient of .275.
This study also suggests a 30-year cycle in it is an inverse correlation as the correla- In the above examples, the Expectation
stock valuations, as an investor would have tion coefficient is -.559. So, as the trailing method is a more superior estimator of
to hold stocks for 30 years to reach from Is-year average has increased over time, future performance than the method of
crest to crest. A 30-year cycle could also the subsequent return has decreased, and assuming the historical averages will con-
help explain why stocks can stay in over- visa versa. Accordingly the phrase “past tinue in a linear fashion.
valued territory for so long. performance is no guarantee of future per- So, why is the “return since 1926” and
How might the Expectation method formance” is more than just a disclaimer. the trailing returns used so frequently?
work in actual practice? A comparison can IVhereas, the Expectation method pro- The main reason is that the rates of return

MTA JOURN;V. l Itinter - Spring 1997 27

 for the last few years have been far above market returning to average levels of valu- placement value of net assets, a premium
those predicted by the Expectation ation (or less). h couple of recent ex- ostensibly for “good will.” ” (If business is
method; indeed even exceeding the his- amples of historic markets that regressed so good, why don’t they simply expand
torical averages. Furthermore, the divi- to the mean after reaching historic highs production by buying additional plants
dend yield has been at historic lows, at or would be the U.S. bond market in the earl\ and equipment at an SO’% discount?) .h
less than a 3% dividend yield, since the first 1980’s, which produced the highest inter- “good will” is a premium paid for compa-
quarter of 1992, a couple of thousand DJIA est rates in the histoy of this republic, and nies with above-average future earnings
points ago, causing some to question the the Japanese stock market in the late potential, how could it be possible that the
validity of historic valuations, such as the 1980’s reaching extraordinary levels of average company is 80% above average? ‘li
dividend yield. As Alan Abelson has wryI! valuations. The real question then is not Ergo, the argument that companies are
written, “(E)verrone knows in this New whether histon- is bunk, rather it is which smarter to buy back their own stock at his-
Era-New Age-Neiu Paradigm market, his- histo? is bunk’- recent history or ancient toricall!- high levels ofraluation isjust plain
tory is pretty much bunk.” ’ histon: Consequently, in contemplating sille
this “kew Era,” particular attention will be ‘The argument being made here is not
“You see I’m sort of paid to some factors given credit for bring- that stock bwbacks cannot inflate the
independent, of a clever age ing it about in an effort to debunk it. price of the siock. Rather, it is that the
descendant” 8 Conventional wisdom says that divi- stock buyback programs are of a transiton
dends do not matter anymore in this new nature predicated upon companies having
It is time now to switch gears, to put
era. An argument against using the divi- excess liquidity to engage in such buy-
the r”s and correlation coefficients aside
dend yield as a measure of valuation is that backs. In turn, this excess liquidity is coil-
(for a while) and ponder this “New Era.”
the payout ratio of earnings is very low, ditioned upon a healthy and growing
By numerous measures, besides the divi-
which makes the yield lower than it would econom!- as recessions tend to dry up the
dend yield, this market has gone to ex-
be under an average payout ratio. ” The excess liquidity in the economl: Conse-
tremes in valuation: the Price-To-Book
payout ratio on any stock is set by its man- quently, during a recession, companies will
\‘alue is 3.8, a new record; the Yield Ratio
agement and its board of directors (here- have less liquidi5; to buy back their stock,
of 30-year Treasu? bond to earnings yield
inafter management). The payout ratio is regardless of then intelligence quotient.
on S&P 500 is 1.4, higher at the peak of
therefore subject to the management’s It could be then that these stock buyback
only one other bull market which was 2.2
long-term view of the company’s and its programs might accentuate the cyclical
in August of 1987; Tobin’s Q ratio (the
indust@s earnings prospects. ‘” This au- swings of the stock market along with the
ratio of stock market value to corporate
thor does not know of any statistical stud- up and downs of the business cvcle - that,
net assets at replacement cost) is 1 A, a new
ies showing that management is more of- of course, remains to be seen.
high; the dollar value of the stock market
ten wrong than it is right in setting the Stock buyback programs might be con-
is now lOl%t of nominal GDP, a new
payout ratio. On the contrary, there is tributing to the levels of valuation along
record; the number of weeks it takes a
evidence that returns received by stock with other forces of demand in the mar-
manufacturing employee to buy one S&P
picking strategies based on a companv’s ket. But, before looking at other forces of
share is 1.25+, approximately equal to the
dividend yield (relative to the market’s d&i- demand, it would be helpful to review the
previous record set in 1929.” The market
dend yield) exceed the overall market re- market itself with these forces of demand
having gone to such extremes in and of
turns. “’ The implication being that man- in mind. The stock market is an ongoing
itself questions the validity of measures of
agement is more often right than wrong public auction of ownership interests in
valuation. ProfessorJames Tobin received
in setting the payout ratio. Consequently corporations, although the volume of
a Nobel Prize for developing his Q ratio,
the low payout ratios cannot be shown to shares traded daily is only a small fraction
which has a normal valuation around SO%,
be a “New Paradigm.” Rather, an indica- of the total shares outstanding. At the end
causing some to observe that the market
tion that management believes the current of each day, every portfolio containing
is making a $3 trillions dollar bet that he
healthy business cycle to be transitory. shares that could trade in the stock mar-
should return his prize (i.e. should the
Conventional wisdom also holds that ket is revalued based on the closing price
market return to normal valuations, the
companies are smarter for buying back for those shares that did trade in the mar-
total market valuation of stocks would be
their own stockwith its inherent “goodwill” ket. Consequently the $6.9 trillion of to-
reduced by, $3 trillion). ‘” Accordingly the
value than paying out dividends which are tal market capitalization is arrived at by the
problem wth valuation models is that this
subject to double taxation. ” First of all, daily auction valued at less than l/dOOth
bull market has pushed valuations beyond
purchases of treasury stock are not tax of the total market capitalization. Ii Forces
historic levels. That is to sa!; history is
deductible by corporations either, so in of supply and demand on the daily trad-
bunk.
this respect t!eT are no different from the ing therefore have a tremendous leverage
Be that as it may, this is a historic era
payment of dividends. Also, the increase on the total market valuation.
for the stock market in terms of lofty valu-
in capital gains (if am) accruing thereb! A familiar reason given for this bull
ations. However, as this may be a historic
to the remaining shaieholders is not tax market is the aging Baby Boom genera-
era for stock market valuations, it does not
exempt, but tax deferred and subject to a tion. The Boomers are said to have a need
necessarily follow that the recent market
capped capital gains rate at the federal to save for retirement. This need has been
performance will continue indefinitely, in
level. Furthermore, the tax consequences postulated to power the market through
keeping with the “New Era.” Rather, the
are irrelevant to all those shares in retire- the year 2010.” The basic demographics
recent bull market may prove to be an
ment plans, which are tax deferred. Lastly, for this argument are supported by the
anomaly brought about bp various factors,
some companies are buying back their own U.S. Bureau of Census and illustrated on
which, when they subside, will result in the
stock at an average 80% premium to re- the top of the next page. This chart illus-

28 MTA JOURML l \Cinter - Spring 1995

 Age Group trates over time the changes in various age groups as mea-
sured by those groups’ percentage of the population as a
whole. The chart illustrates the Baby Boom generation caus-
ing the 45-54 year age group to peak around the year 2010. A
Federal Reserve study found that stock ownership as a per-
l&W% centage of financial assets peaks around retirement age of 65,
which means a peak in stock ownership for Boomers around
14.oon 2025.‘” However, this rosy scenario cannot be demonstrated
to have any historical jus&ation. Of all the age groups, the
12.00% group with the highest correlation to the DJLJ is the 35 to 44
year age group (population numbers rather than percentage
lO.mn
to the whole), with an r? of ,855 for the years 1914 through
1995, as charted on the left. Other population groups hare
no greater correlation than that of total population itself, with
( aaonr ,
1900 lo20 1940 1060 100 2om 2020 an r’) of .65. As can be seen from the chart of the 35 to 44 vear
age group, the major increase in this age group has coincided
DJIA M 35 to 44 Year Okls with this bull market, although the this age group is topping
“T I out and will decrease after the year 2000. This age group
could have a greater correlation with the stock market be-
cause it offers greater net buyers in the dail! market auction.
Though older age groups could hold more stock, holders do
not drive the market, buyers and sellers do. Seemingly,
Boomers shouldn’t trust anyone over 50, to drive the stock
market up that is. (It should also be noted that the market
can experience significant corrections even as the 35-44 year
age group increases. For example, the severe bear markets of
the 1930’s occurred even as this age group increased, albeit
at a slower rate of growth than in the 1920’s.) TYhile the sig-
nificant recent increase in this age group could alone explain
our historic valuations in the stock market, there is another
demand force that bears examining, that being liquidity.
The Federal Reserve has an army of followers with various
DJIA vs Dollar Liquidity
disciplines because of the Fed’s agility to control monetan
too0 policy and influence interest rates. Lately some have argued
that foreign central-bank purchases of U.S. Treasuries also
add to our liquidity and, therefore, increase demand in the
stock market, in addition to other economic effects. ‘?” The
market has appeared to have confirmed this theory by having
a good correlation with the Fed’s Moneta? Base, the Fed’s
reported “Foreign holding of U.S. Debt” and the sum of the
two (hereinafter Dollar Liquidity). ” The chart on the bot-
tom left illustrates the correlation between the DJIA and dol-
lar liquidity (the sum of the monetary base and foreign hold-
ing of U.S. debt), an r? of ,935 for the time period 1941-1995.
As a result of this high correlation, it could be reasonable to
assume the bull market will continue until liquidity dries up,
and all one need do is monitor liquidity. The fault with this
line of reasoning is revealed in a close inspection to the 1972-
75 time period. During this bear market, the DJW can be
seen dipping below the dollar liquidiF, line significantly while
dollar liquidity is shown to be increasing. By measuring the
DJW and the three basic monetary measures discussed above
with a trailing 25-year time frame, the present high correla-
tion is shown to be a fairly recent phenomenon. As shown on
second chart on the bottom left, the last time there was as
close a correlation was during the last bull market. Unfortu-
natelv for the Fed watchers, the correlation broke down when
in 1969-70 the DJL1 corrected while dollar liquidity kept on
increasing.
Again, in the absence of a cogent argument identifying
some forces in the market disrupting the relationship between
liquidity and the stock market, the occasional and present cor-

MTA JOURNU l \Vinter - Spring 1997 29

 DJIA vs 10 Day Average Volume relation might just be statistical flukes. If liquidity does af-
fect demand in the public auction of stocks, then perhaps
the resolution to the monetan- model problem lies in exam-
ining supply.

“My star is on the ascendant” 22

If increases in liquiditv increase demand for stocks, the
price of stocks should go up, as they have recently. The wild
card that needs to be taken into consideration is the suppl!
of stocks reaching the market. Ignoring the effects that new
issues have, just a scant increase in sellers can greatly expand
the supple of stocks available to soak up anv conceivable
amount of liquidity An example is provided in the top chart
left, a comparison of the DJM to lo-day average volume (as
measured by advancing plus declining volume) on the NYSE.
The August to October 1973 rally saw the DJIA increase 15.5%
CumulatiieVohme during that time period while IO-day average volmne in-
creased 102%. Based on the price change alone, it would
take 15%’ more money to move the market any given per-
centage. For example, to increase a SlOO stock 1% would
take a purchase at $101, an increase of $1 in absolute dollars.
But, should that stock increase 15% from SlOO to $115, a 1%
further increase would require a purchase at $116.13. This
represents an increase of $1.15 in absolute dollars and 15%
more money than at the $100 level. Then, to compound
that, with volume expanding 102%, it would take 130%
(2.02*1.15) more money to move the market any given per-
centage, therefore supply overwhelms demand.
The hypothesis that supply is being increased by holders
turning into sellers is confirmed bv the second chart on left
Ten Day Average Volume vs Cumulative Volume titled Cumulative Yolume, a running total of the h?iSE daih
up volume minus down volume, equivalent to cumulative daih
-- breath. From its peak of 341,790,OOO on 12/11/72 (wherk
Cumulati\-e I’olume = 0 on l/l /70), the highest it could rise
to in the October ‘73 rally was 207,080,OOO on 10/12/T3,
nearly 40% lower than the December ‘72 high. As for the
DJM, its peak at 987.05 on 10/26/73 was 6.1%’ lower than
the l/11/73 peak of 1,051.iO. Mllereas, the lo-day average
volume showed a marginal increase in the October ‘73 ralh
over the previous high in November of ‘72. This prepondei-
ante of selling going into the ‘73-74 bear market is illustrated
bp the top chart above comparing the 10 Day .Iverage \‘ol-
ume to the Cumulative Yolume.
As for the current market, the Cumulative Volume bot-
tom chart above shows the tremendous strength in this mar-
ket, and it has recently reached a new high. As long as the
Cumulative Volume investors in this market remain holders, the forces of demand
nm will continue to levitate the market. ;Uthough an allusion
LA here will not be made to the “tulip-mania” “:‘, another Low
Count? legend seems appropriate, that of the Little Dutch
Boy with his finger in the dike (daily trading volume) hold-
ing back the rising waters (total market capitalization). I$%at
y11ml rnlRs A@# might cause the dam to burst remains to be seen. although
rising interest rates are quite possible. “’ M’hatever the cause,
its effects on Cumulative I’olume will help to gauge the flow
of selling.

“That’s why I don’t care.” 25

In summation, as market valuations are determined b\
the daily market action, in which less than 1/400th of thk
total market capitalization actuallv trades hands, valuations

MTA JOURML l \Vinter - Spring 1997

can be driven to extremes in times of great
demand for stock. FVith this amount of
leverage on market valuations, it is diffi-
cult to argue that measures of valuation,
such as the dividend yield, place any sort
of upward limit on thk stock market. The
thin float on which market valuations rest
is a double edged sword. Should a small
fraction of the holders, who on the aver-
age day outnumber active traders 399 to
1, decide to become sellers, they would
overwhelm this thin float, driving prices
down towards (and possibly past) the mean
valuations.
Valuation models, such as the Dividend
Expectation, can be very helpful in main-
taining a perspective on the market. A-
though the nature of valuation models if
used alone would result in investors get-
ting out too earl!; missing out on the lat-
ter bull rallies when stocks get even more
overvalued, and getting back in too soon,
while stocks become even cheaper. For in-
vestors using valuation models, patience
is not a Yirtue, it is a necessity Alterna-
tively, investors might look to the tape and
forces of supply and demand acting on the
market for clues as to when the forces driy-
ing the market to extremes in valuation
hare been expended and the pendulum
starts to swing back to the mean.
Footnotes
1. From the song “‘I Don’t Care, ” Harry 0.
Slltto?l (1905).
2. E.g. John I! Hussman, Hussvnan Econo-
metrics, Nay 3, 1995, (see also ‘tLLlav-ket
Tlhtrh, ” Ba&n ‘s, i\lay 15, 1995, at 42).
3. As investments are aform ofsavings, a store
of wealth for future consumption, the nu-
thor belieues that real-total rate of return
provides the best measure of the increase ov
decrease in an asset’s $nlrchasingporoeI; es-
peciall! given the study period of 1926
through 1995, which includes peviods of sig-
nificant inflation and deflation.
4. .A cursor:) reuiew of Federal Resnve data
on households’ securities as a percentage of
total assets would indicate a similar 30 year
yle, which could be a rnusalfactor in the
ualuations yle . though time and space
do not allow for a though ,witzo and analp
sis of said data.
5. “T&e nuvnberE(X) is also called the expected
value of X or the mean of X, and the terms
expectation, expected value, and vnean can
be used interchangeably. ‘I ,Uorris H.
DeGroot, Probabilit! and Statistics, page
144, (lYi5).
6. Ibottson dssociates, SBBI 1995 Yearbook. 25 Han? 0. Sutton, Ibid. Eua Tavpa? lost
her fortune during the stock market crash
i. Alan dbel.ron, “(‘I LJ Down Il’nll Street, ”
of 1929 and spent the last two decades of
Barron ‘s, .\huember 18, 1996, at 5.
her lifp a bedridden recluse. The .plu EW
8. Harry 0. Sutton, ibid. rylotiedia Britannica, supra note 22.
9. Patrick ,IlcGeehan, ‘L-lbreast of the dlnr-
ket, ” The TM1 Street lournal, June 3, 1996,
at Cl; Alan Abelson, “c-p LY Down llnll Gregory J. Roden
Street, ‘IBarron ‘s,June 17, 1996, at 5, ,\‘IaJ GregoF Roden is a Trust Officer
2i, 1996, at 3, .Youember 27, 1995, at 3,
at Nonvest Bank Minnesota, S.A. in
and March 25, 1996, at 3; .-indrpru Bary,
“l’ntested Ilhters, ” Barron Is,Sovevnber 23, Bloomington, MN. He received a law
1996, at 1 i. degree from South Texas College of
Law in 1991 and a B.B.A. in Actuarial
10. Alan Abelson, “(‘1, ti Down llnll Street, ”
Science from the University of IYis-
Barron’s, -\lay 2i, 1996, at 4.
consin - Madison in 1979.
11. dbby Joseph Cohen intevvinu, “Still Bull-
ish,; Barron ‘s, October 14, 1996, at 26.
12. Anthony E. Spare, RelativeDividend Ii’eld,
page 15, (1992).
13. Anthony E. Spare interview, “A Diuidend’s
Yield, I’ Barron Is, October 28, 1996, at 30;
dndrero Bar!, “World-Beatev; ” Barron Is,
Februa~ 12, 1996, at 15.
14. Kathry 111. Il>lling, “Boring Doubles, ‘I
Barron Is,June 10, 1996, at 22.
15. dkan Abelson, “l’p LG Dorcv2 ?li?ll Street, ‘I
Barron Is,June 17, 1996, at 5.
16. Ibid.
1 i. 16 ‘%u~&k Stock Exchange Data Bank, ‘I
Barron ‘s, .Vovember 25, 1996, at MI’1 06.
18. Harry S. Dent, The Great Boovn Ahead,
page 34, (1993).
19. Federal Reserve Bulletin, October 1994.
20. Randall IV. Forsvth, “Pumped l’p, ‘I
Barron’s, lllarch 18, 1996, at 15; John
Jluellev; “The Real Conspirators Behind
High Gas Prices, ‘I The MU1 Street lournal,
May 8, 1996, at A14.
21. “Federal Reserue Data Bank, ‘I Barron Is;
Federal Reserve Bulletin; Annual Statisti-
calDigest, 1970/79 and 1980/89editions,
FederalResevueSystem; Bankinpand Mon-
eta?1 Statistics, 1941-l 970, Federal Reserve
System.
22. HarT 0. Sutton, Ibid. 7Dov2’t Care” loas
made popular by Eva Tanguay, the “Girl
Il’ho L1llade lhudeuille Famous” and
shocked audiences zoith her scanty costuvnes
and risquesongs. See lbluvne 11, TheAYew
Encylo$edia Britannica, 15th Ed., at 542.
23 Alexandre Dumas, The Black Tulib, page
ix 011. Girard rd. 1960).
24 E.g. John I? Hussvnan, Hussman Econo-
metrics, June 6, 1996, (see also “‘Market
Wtch, ‘I Barron’s, June 1 i, 1996, at 44).
MTA JOURil4L l \\‘inter - Spring 1997
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left blank.

32 MTA JOURNAL l TVinter - Spting 19%

 Market Noise. Can It Be Elimated And At What Cost?
Introduction
As the proverbial rustling of a cand!
wrapper - during a Beethoven piano con-
certo - distorts the music for the listener,
so noise in market data distorts the
analyt’s perception of the trend in the
price.
But what is market data noise? The
nature of fluctuations about a mean value
is a common experience and is often re-
ferred to as noise. Noise in data is the mi-
nor random price movement that distorts
the underlying trend, making it difficult
to detect the direction of the price at any
time. However, this is rather a vague de!5
nition, as it does not help to define what is
noise and what is significant price move-
ment. What may be noise to one analyst is
‘music’ to another. Part of the answer lies
in the analyst’s analysis method and time
horizon. Some Technical Anahsis tech-
niques rely on eyen the smallest price
movement. Furthermore, the longer
the time horizon, the greater the pro-
portion of price movement that can
be defined as noise. This, however,
brings subjectivity into noise defini-
tion and adds to the complex job of
defining it before it can be elimi-
nated. But should we attempt elimi-
nate noise, or can we only reduce it?
Chart A show the a daily close
line chart of BAA (British Airports
Authority) from October 1993 to
February 1996. The price changes
every da): One day it is up, the next
it is down. An inexperienced eye
may have some difficulty in deciding
the direction of the trend of BAA at
any time. This uncertainty is caused
bp noise - those price movements of-
ten against the prevailing trend that
tend to disguise the trend.
Technical Analysis is essentially to
do with trend recognition, so any-
thing that makes that task more dif-
ficult must be investigated, and if
possible, eliminated. The elimina-
tion of market data noise raises many
questions, the main being that in
order to eliminate it, it must be dis-
creteh defined and identified. Be-
cause’identilication of market noise
is somewhat subjective, it is virtually
Jeremy J. A. du Plessis,CMT
impossible to discretelv identih it for each
instrument. In view of this, noise elimina-
tion must be considered impossible, mak-
ing noise reduction a more realistic target
to aim for.
This article will, therefore, investigate
traditional methods of noise reduction as
employed by Technical Analysts, and look
at the advantages and disadvantages of
each. The article cannot, however, cover
digital filtering processes employed by
Electrical Engineers to filter noise. M’hilst
these may be applicable to price data, it is
not the purpose of this article to become
highly mathematical. The majority of
Technical Analysts employ charts to deter-
mine price direction and wish to hare rela-
tively simple method of reducing noise.
For those readers who wish to investigate
the route of signal processing, ybernet-
its, spectral analysis and digital filtering,
however, several references are included
MTA JOURNAL l \Vinter - Spring 19%
at the end of this article.
Once some of the traditional methods
emploved by Technical Analyts have been
discussed, the article will then look at a
simple, innovative method of objectiveh
removing noise from data, and with inves-
tigate whether the results warrant it as a
method that non-mathematicians can
employ.
Is Noise Bad?
Before we investigate noise reduction,
it should be noted that not all Technical
Analysts want to reduce noise. Elliot-
ticians, for example, use even the small-
est, seemingly random, price mo\-ement
for their wave counts, and so prefer to use
the raw price data and not data that has
had noise reduced. The assumption in this
article, however, is that noise is bad and,
therefore, its brief is to investigate way of
reducing it. The article will show that
there are significant benefits in re-
ducing noise.
Elements of the Pricing
System
Carlson’ describes the contamina-
tion that occurs in the course of sig-
nal transmission within an electrical
communication system in three ef-
fects: distortion,’ interference and
noise. These contaminations are
analogous to those found in market
price movements, which cause cer-
tain unwanted and undesirable ef-
fects to take place. They alter the
shape of the price pattern, making
analysis more difficult. The three
categories can be described as fol-
lolvs:
Distortion is the least important
of the three and is due to imperfec-
tions in the pricing process. For ex-
ample, some price recording systems
use the mid-price-the price behveen
the bid and offer - rather than the
price at which a particular share or
commodity has traded. This can lead
to distortions because it is possible
that no trading may have taken place
at the mid-price quoted at the end
of the trading period. The argu-
ments for and against the use of mid-
33
 prices as opposed to traded prices are
equally strong. Proponents of the mid-
price system believe that the system avoids
the occasional rogue traded price from
being recorded as the last trade of the day.
\\‘hichever method one subscribes to, the
result will be some distortion in the price,
although consistent use of one or other
method will lessen the effect.
Interference is contamination of the
price by extraneous factors. The price re-
cording system itself mav be deficient.
Some price recording systems are initiated
by a manual process, where human error
can have an effect on the data. Like dis-
tortion, interference can be eliminated b\
improving the recording system.
Yoise on the other h&d, is random
-3
and unpredictable, and is caused bp the
pricing process - the interaction between
thousands of buyers and sellers with dif-
fering and ever changing perceptions
about the value of the instrument that the!
are buying and selling. These changing
perceptions can cause the price to move
against the prevailing trend, often disguis-
ing it. M’hat makes noise unique, however,
is that it can never be completely elimi-
nated - even in theory
Traditional Ways in which
Technical Analysts Reduce
Noise
There are many way bv which Techni-
cal Analysts attempt to reduce noise. \Ve
will look at three important methods in
depth - Moving Averages, Filtered \Vave
Charts and Point & Figure Charts. r\‘e will
then comment on other methods, such as
Gann angles, Speed/Resistance lines and
Regressions lines, without going into
depth.
Moving Averages
One of the most common way of re-
ducing noise and exposing the trend is the
use of a moving average. This can either
be a simple arithmetic average or a
weighted exponential ayerage, but the
function of each is the same - to average
out the price movement, thereby reduc-
ing the noise.
Chart B shows the price of BAA super-
imposed with a 20-day simple arithmetic
moving average. Notice how the average
eliminates some of the minor price move-
ments and corrections, making it easier to
see the direction of the price at any stage.
Chart C shows the price of BAA with a
2Oday exponential moving average. The
result is similar to that of the simple aver-
age. Because of its weighting to the latest
34
data, however, the exponential average the original price line with a new noise-
tends to turn sharper than the simple a\: reduced line. In this case, it is the moving
erage and is thus preferred bv some ana- average line. But can we trade using this
lysts. line instead of the price line, because that
Let us now remove the price from the is the goal?
chart and replace it with the moving aver- Observing Charts B & C, you will see
age alone. Chart D shows the 20-day ex- that although the mor-ing average exposes
ponential average on its own. the underlying trend ve1T effectiveh. there
The noise in the data has certainly been is a time lag. In other words, there’is a lag
reduced, making it easier to see the direc- of a number of davs or weeks before the
tion of the trend at any stage. But how do moving average indicates a change in
we know we have removed the right trend. The greater the moving average
amount of noise? Perhaps we have re- period, the more noise/trend is removed
moved too much-perhaps too little. Let’s and the greater the time lag.
look at an extreme situation. Chart E Filtered Wave lines
shows a 200-day exponential average on its
&~iother way to reduce noise is to re-
own. One can see that not onlv has noise
place price with a series of straight lines.
been removed, but many of’the trend
These lines, called Filtered M’aves’, are
changes have been removed as well.
drawn from intermediate highs and lows
So, moving averages can reduce noise, avoiding all the price movement between
but how efficient are they in doing so, and
them. Unlike moving averages, filtered
what are the advantages and disadvan-
waves use the actual price at turning
tages?
points, making them useful for trend line
At first observation, they are fairly good
analysis. They are ideal for drawing trend
at reducing noise. They certainl; do ex-
lines and Gann angles, because the minor
pose the underlving trend. The duadvan-
price movements are excluded without ex-
tage is that the period selected for the
cluding the major movements and turn-
moving average is subjective. In the ex-
ing points.
ample above, a 20-day average was chosen.
It could just as well have
been a lo-day or 40-day or
even a 200-day as shown in
Chart E. Each period of ay-
erage eliminates a different
amount of the noise - or
genuine price movement.
The greater the moving a\--
erage period, the more
noise and trend are re-
moved. The lower the pe-
riod, the less noise and
trend are removed, until a
moving average period of 1,
which is the original price
itself, is used and no noise
is removed at all.
But when does this pro-
cess move out of the bounds
of noise reduction and into
the domain of price more-
ment removal? A 200-da!
moving average removes
most of the intra-month
price movement and ex-
poses the long-term trend of
the market. The question of
what period to use and how
much noise should be re-
moved continually plagues
analysts, because there is a
tradk off. The purpose of
removing noise is replace
MTA JOURNAL * \Cinter - Spring 1997
 If the intention is to eliminate noise
between intermediate turning points, then
filtered waves do the job very well. Once
again, however, they are subjective, be-
cause the analyst must decide how much
movement he &ants to eliminate. Chart F
shows a 10% filtered wave chart of B.A.I.
This means that any movement from an
intermediate high or low which is less than
10% is ignored. The result is a very effec-
tive chart, which removes much of the un-
certainty in the trend.
Chart G shows a lo-point filtered wa\-e
chart. The calculation is similar to that of
the 10% chart above, but instead of ignor-
ing price movement which is less than 10%
from an intermediate high or low, it ig-
nores any which is less than 10 price units
- points or cents or pence. In both cases,
the actual price turning points are shown.
This distinguishes the method from the
moving average method. It is easy to see
how the filtered wave method reduces
noise. It is replacing all the minor price
movements between intermediate highs
and lows with straight lines that go straight
through the price movement. It is impor-
tant to note, however, that the final straight
line cannot be drawn until the price has
reversed bp the required amount.
Some analysts draw the latest plot
to the latest price, but this is not
correct and can be very deceptive,
because it looks like a reversal has
taken place, when in fact it has not.
This writer prefers to draw a hori-
zontal line (see Chart F) from the
last intermediate high or low until
the latest price moves the required
percentage or points away from it.
There is, therefore, a built-in lag in
filtered wave charts, in that the last
plot can only be made once the
price has moved by the filter
(points or percentage) amount.
This is obviously a disadvantage in
one sense and an advantage in an-
other. The disadvantage is that the
chart is only up to date when the
price reversal is complete, which
makes it difficult for the analvst to
complete his analysis. But in an-
other sense, this’is exactly what
noise reduction is all abodt. L\‘e
must assume that any price move-
ment below the reversal percent-
age, is noise; and, therefore, the
analyst should be unconcerned b)
this movement until it breaks the
reversal barrier.
It has been said that filtered
wave charts are no good for trad-
ing, because they are drawn with the ben-
efit of hindsight. This is not entirely true.
If ther are constructed as described above,
then ‘it is possible to trade using the fil-
tered wave chart bv waiting for the chart
to turn. For example, Chart F shows the
price and hence the filtered wave line
reached a high in July at 535 and then
turned down reaching a low of 465.5 in
October. Since then, although the price
has risen, it has not risen by more than
10% from the low point of 465.5, so the
trader is still short waiting to go long if the
price does rise by more than 10% from the
low. Of course, If the price falls below the
465.5 low, a new: line from the 535 high
will be drawn to the new low. (The per-
centages used here are simply to illustrate
a possible trading strateg- and are by no
means optimised for the chart in ques-
tion.)
So, what are the advantages of filtered
wave charts? Thev are simple to read and
ident@ the trend kxceptionallv well. They
can be used for objective trading by select-
ing a filter percentage (or points) and
waiting for the waves to turn. But there is
another area lvhere wave charts are better
than moving averages, and that is for trend
MTA JOURSAL l \Gnter - Spring1997
lines, speed/resistance lines, Gann angles,
retracements, in fact any straight line ana-
lytical technique. The reason for this is
that wlike moving averages which alter
the original turning points, filtered wave
charts use the actual data for turning
points.
The disadvantage, however, is the fact
that the filtered wave does use straight lines
which may not be the best wav to reduce
noise. Chart H shows a 10% filtered war-e
chart of BA% again, but this time it has
been superimposed over the actual close
price. Notice how, unlike moving averages,
the straight lines go straight through the
price. There is no offset to the right, which
occurs with moving averages. The straight
line turns on the intermediate highs and
lows and it, therefore, appears that there
is no lag, but this is deceiving. Remember
that the straight lines can only be drawn
once the price has reversed by the appro-
priate amount - 10% from the high or low
in this example - so there is a consider-
able lag.
Point & Figure Charts
Because of their construction, Point &
Fig1 u-e charts have an in-built noise reduc-
tion capability. This is manifested in
two ways, by altering the box size as well
as the box reversal. Before drawing a
Point & Figure chart, the analyst must
decide how many price units are to be
assigned to each box. The greater the
box size, the greater the amount of
noise is removed. This is because the
price must move by a larger amount
before the chart changes. The rever-
sal size also play a part in eliminating
noise by ignoring retracements which
are less than the value of the reversal
size.
Let us look at the example below to
see how this works in practice.
10s 3 Point8: FigureChart
110 <-pm mwt rr~h I IfI h next \ IO hr pluttid
100 X
90 x0
80 x0
X 10 x 3 Point 8: Figure chart is one
i where the box size or value is 10 price
35
 units and the reversal size is 3 boxes or 30
price units. To see how the filteringworks,
let us assume that the price is in an uptrend
at 100 signified by the column of x’s. In
order to plot the next up-X, the price must
move to 110. If it reaches 109, no plot will
be made. On the reversal side, the price
must fall b? 3 boxes or 30 price units to
70. If it falls to 71, a fall of 29 points, the
reversal will not be complete and the chart
will not change. So, this means that the
price can fluctuate between 71 and 109
without it effecting the chart. Assume,
however, that the price does fall to 70 and
a column of O’s is plotted, signifying a
downtrend. Once this happens, the filter-
ing mechanism changes. In order for a
new 0 to be plotted, the price must fall b!
10 price units to 60, but for a new column
of X’s to be plotted, the price must rise b!
3 boxes, to 100 again. So once again we
have our range of prices 61 to 99 between
which there will be no change to the chart.
In this way, noise or minor price changes
are removed from the chart, but not the
data. The original data remains unaltered.
Altering the box size and the reversal al-
ters the amount of noise, which will be re-
moved from the chart. Although this
method is a similar technique to that
of the Filtered Wave chart,.it has two
important differences. The first is
that the filter in Point &Figure charts
is different in the direction of the
trend from that against the trend. As
we saw in the example on page 35,
the filter in the direction of the trend
is 10 points, but against the trend is
30 points. The second difference is
that Point & Figure charts take no ac-
count of time. Although this does
not appear to have any significance
in the noise reduction process, some
analysts prefer not to use charts with-
out a time dimension.
Chart HH shows a 2 x 3 Point &
Figure of BAA. Each X and 0 repre-
sents 2 pence and the price must re-
verse by 3 boxes, or 6 pence in order
to change columns. The chart
should be compared and contrasted
with the line and filtered wave charts
of BAA shown earlier.
M’e have discussed three tradi-
tional ways of reducing noise, but we
need to acknowledge other methods
which are used by some Technical
Analysts.
Regression Analysis
Noise distortions can be removed
from a price series by using Ordinay
36
Least Squares Regression Analysis. M’ith
this method, a series of price data is re-
placed by a mathematical best-fit straight
line, which best represents the price ac-
tion. The line and its slope are direct)
influenced by the data under consider-
ation, so that choosing the section of the
price data to be analysed has a major ef-
fect on the regression line.
The regression calculation needs to be
run often as new data is added to the end
of the time series. The angle of the re-
gression line then changes accordingly.
The analyst will choose a starting point in
the time series and continue drawing re-
gression lines on a regular basis so that the
latest direction of the price can be deter-
mined.
Chart HHH of BAA shows a number of
regression lines that have been drawn each
month from a common starting point of
‘i/3/95. Each regression line shows the
trend of the share price from T/3/95 to
the end of the month in question. The
fan-like appearance shows that the steep-
ness of the trend has decreased over the
months up to the current date. An ana-
MTA JOURNAL * \Cinter - Spring 1997
lyst using this method w-ill use the angle of
the regression line to assist in determin-
ing the underlying trend.
Gann Angles, l/3 2/3 Speed
Resistance lines
As stated earlier, Technical Xnalysis is
to do with trend recognition, so if a
method can be found that identifies the
trend without being ‘confused’ by noise,
then the method must be regarded as a
noise reduction technique.
Gann Angles are objective angles,
drawn from a high or low point at a num-
ber of price/time ratios which identify,
objectively the trend and the points at
which the trend can be expected to
change. In this way Gann analysts can ig-
nore much of the price movement unless
one of the Gann angle lines is intersected.
Although Speed/Resistance lines have
a different basis for their construction,
they perform a similar trend recognition
task. They are also drawn from low or high
points and indicate the levels at which the
price can be expected to supported or re-
sisted.
.4 few traditional noise reduction tech-
niques employed by Technical Analysts
have now been discussed. Although
this writer is aware that there may be
many more ways in which the n&se
in the data can be reduced, the
methods discussed so far are suffi-
cient to give some background to
this complex problem, before pro-
posing a novel method. Before do-
ing so, however, let us now look at
how these traditional methods per-
form when traditional Technical
Analysis techniques are employed.
Applying Traditional
Analysis Techniques to
Noise Reduced Charts
Having identified a number of
noise reduction techniques, we now
need to apply Technical Analysis
techniques such as trend lines, mov-
ing averages and oscillators to charts
which have been subjected to noise
reduction.
Trend lines on Noise-Reduced
Charts
This writer is sceptical about the
value of using trend lines, or an!
straight analysis technique on mov-
ing averages. This is because mov-
ing averages no longer haye the
original data. There are no original
turning points, hence there is some
doubt as to whether trend lines, l/3 2/3
speed resistance lines, Gann lines, etc. can
be used on these charts. However there
are those analysts who do use straight lines
on derived charts, with no hesitation.
On the other hand, the filtered wave
method of reducing noise makes the
charts ideal for an!: straight line analytical
techniques. This 1s because the turning
points are the original turning points, with
onl!- the data between the turning points
being altered.
Chart I shows a 7.5% wave chart of Brit-
ish Steel (BS) with the original price su-
perimposed. X set of Gann lines is drawn
from the November 1993 low. Notice how
the Gann 1 x 1 (45x) line offers support
to the uptrend of the filtered wave line and
the price. This is because the filtered wave
uses original price turning points. This
would not happen with a moving average,
because the data is altered by calculation
and the position of the turn’ing points is
altered.
Point &: Figure charts lend themselves
to trend line analysis, particularly 45x lines,
because they are constructed with boxes.
The diagonal line joining the corner of
one box to the next produces a 45x line.
These 45x lines indicate the direction of
the bull or bear trend and provide support
or resistance to the trend.
Moving Averages on Noise-
Reduced Charts
Moving averages are often used to gen-
erate buy and sell signals. M’hen the price
crosses above the moving average a buy sig-
nal is generated; when it crosses below, a
sell signal is generated. This article is not
required to comment on the effectiveness
of this technique, but simply to comment
on whether moving averages can be used
on data that has had the noise reduced.
Chart J show the original price of
Guiness (GUN) with a SO-day simple mov-
ing average. Chart K shows the 10% wave
chart of GUIS with a &day average. At
first glance, the wave chart with the mov-
ing average performs far better than the
actual price with the moving average. The
crossover signals are earlier and there are
no whipsaws, but this is an extremel! dan-
gerous obsemation. There is a built-m lag
in the wave chart in that it does not turn
until the reversal has been reached. So it
looks like the averages have crossed on
time but they have not, because there is
MTA JOCTRNAL l \\‘inter - Spring 1997
the reversal delay This really disqualifies
filtered wave charts from being used with
moving averages.
Chart L shows a 20-day exponential ay-
erage of GUS - in effect a noise-reduced
chart, with a 50-day average superimposed.
The main line is smoother because the
noise has been reduced, so there are far
fewer false signals and whipsaws. There is
of course a trade-off for this, and that is
the signal lag. It is, however, not a con-
stant lag, for example; there is an 8 da!
lag in the sell signal in hlarch 1993; but
only a 4 day lag in the buy signal in March
1995.
Point & Figure Charts do not lend
themsehes to moving average crossover
analysis.
Oscillators
The purpose of reducing noise is to .
make charts more readable and more re-
liable in giving signals, but can the noise-
reduced data be used to draw oscillators?
Chart Ll shows a price of GUIN. Chart
L2 shows a standard 14-day RSIZ (Relative
Strength Index) of the piice. Chart L3
shows a 14-day RSI of the smoothed data
(the 20 exponential average of the price).
 For some, the original RSI is quite dif-
ficult to read, because of the sharp turns
and vigorous oscillations. Chart L3 is far
smoother - obviouslv because it is an RSI
of the 20-day noise-reduced data. But does
the noise-rdduced RSI give better signals
than the original?
1. Certainlr the smoothness of the noise-
reduced RSI makes it easier to read.
The turns are easier to judge, because
there is no noise creating uncertaint!
about them.
2. RSI’s are used for divergence and this
is where there is an improvement with
the noise-reduced RSI. The original
RSI shows no divergence during the
November 1993 to December 1994 top,
nor does it show it during mid 1995.
The noise-reduced RSI, on the other
hand, does show these divergences, al-
beit marginally.
3. The greater extremes in the noise-re-
duced chart make it easier to detect
overbought and oversold conditions.
4. =zS with all noise reduction. however,
there is a considerable lag in the turn-
ing points.
In order to show that drawing an RSI
of a 20-day moving average is not the same
as drawing a 20-da\ moving average of a
14day RSI, chart i4 shows the chart of a
20-day aI-erage of the 14dav RX This
shows a smoothed RSI of the briginal data
instead of an RSI of smoothed data, which
is really what we are aiming for.
This writer does not see the object of
using data from filtered wave charts to
draw oscillators, because only the turning
points are original. The rest of the data is
calculated to create the straight lines.
Hence, no attempt has been made to draw
an RSI of a filtered wave chart.
It is, of course, possible to draw point
and figure charts of the RSI, but this does
not reduce the noise in the price data, but
rather the noise in the RSI, which is simi-
lar to drawing a moving average of an RSI
described above.
The three traditional methods of reduc-
ing noise discussed above, namel!; moving
averages, filtered wave charts and Point 8c
Figure charts, suffer from a number defi-
ciencies - already explained. A%lthough fil-
tered wave charts are an excellent \l-av of
reducing noise for clearer straight iine
analysis, they cannot be used for other
for& of an&is and must therefore be
discarded. 0; the three, therefore, ino\--
ing averages are more flexible, but the
problem is the determination of a suitable
moving average period. How does the
38
analyst determine the period without be-
ing too subjective?
The purpose of reducing noise is to
replace the original data with a new set that
has had the noise reduced. This new data
set must perform like the original in ev-
cry way with the exception that am noise
should be reduced with the hope that this
increases the reliability of the signals. An
objective wa!- of doing this is, therefore,
required and is proposed below.
The Proposal
1. Take a stream of data and smooth
with a moving ayerage.
2. Calculate the trend of the smoothed
data (the moving average) at ever!
point.
3. Once calculated, the trend can be ex-
trapolated to forecast the next period’s
data point.
4. This forecast is then be compared with
the actual price for the next period and
the difference taken.
3. Repeat this process for every datapoint
throughout the data stream and square
the differences to remove negatives.
6. Sum the squared differences to obtain
a total of the squared differences.
The smaller this total is, the more ef-
fective is the moving average in forecast-
ing the next period’s price. In other lvords
the moving average that produces this least
squared error is the best for replacing the
original data. Noise reduction, therefore,
becomes swift, simple and objective.
The Model
The model of the proposal described
above uses an exponential moving average
for two reasons. Firstly it is a weighted
average and so it is effected to a greater
extent by the latest prices. Secondly, and
perhaps more important, it is possible to
have fractional periods. I\%ereas a simple
arithmetic average can onlv hare whole
numbers as the period of the average, ex-
ponential averages are calculated using a
factor, l\.hich when translated into a period
bv the following formula’, translates into
a’fractional period.
f= 2
I1 t 1
where )z is the moving average period
f is the exponential smoothing
In other words, a smoothing factor of .3
equates to a moving average of 5.67 days.
The mathematical model is defined as fol-
lows (see also Appendix B) :
MTA JOURXIL l \\lnter Spring 19%
Step 1 -Calculate the exponential average
The exponential aI-erage EI in period t
Et =f P, + ( l-f)&
\+.here PI is the Price in period t
El-, is exponential a\-erage in period t-l
The initial condition is E, = P,
SteD - Calculate the trend of the moving
average.
The trend T, of the average in period t
T, =f (E;E,J +(I-f)T,.,
rvhere(E,-E,~,) is the difference between the
it exponential average in period t and t-l
T,., is the trend in period t-l
The initial condition is T, = 0
Step 3 - Use the trend of the data to fore-
cast the next value.
The forecast FL+, for period ttl
F,., = E, + L TI
f
Step 3 - Compare the forecast price with
the actual ’
Difference d, = FI - P,
where P, is the actual price in period t
Fi is the forecast price for period t
Step 5 - Square the differences and sum
them
11
Total squared difference = x dl’
t=l
where n is the number of data points
d,” is the square of the clifference in t
Step 6 - Find the least squared difference
by trial and error.
In practice, it has been found that it is
best to start with a factor of 0.5 and test
factors either side of this until the least
squared error is found. ;\ computer per-
forms this task veT quickly. Once the fac-
tor is found, an exponential average us-
ing this factor is drawn to replace the origi-
nal price.
Sow that we have the model, let us look
at some examples to see whether this
method can be relied on to gir-e superior
results. For consistency we l\ill first look
at BA\ and then at some wider markets.
For comparison, chart Rl shows the
price of B.U. with a new noise-reduced
line in chart R2. Ah explained above, this
line is an exponential aI-erdge using a fac-
factor tor determined by the least squares differ-
ence method. In this case the factor was
found to be 0.527. which equates to a
moving average period of 2.795 davs.
Comparing the hvo charts, it is easy to see
 to a moving average of 1.447 days.
the effect that it has had on the data. Much turning point lag has not changed, as seen
of the minor price oscillations have been by the vertical lines. Chart R4 shows the l 3rd reduction factor of 0.921 equates
removed without destroying the trend; result of applving the noise reduction a to a moving average of 1.171 davs.
even the short-term trends are still intact. third time. Therefore, in order to obtain chart R4,
It seems that the quality of the data has It is significant to note that the chart a 1.171 day exponential average is calcu-
been improved by this reduction of noise. patterns appear much clearer. lated from a 1.447 exponential average of
The line is smoother and less erratic and For example: a 2.795 exponential average of the origi-
there is generally no lag. Vertical lines 1. There are two Double tops, one in Janu- nal price. This allow the analyst some
have been drawn from various highs and ary/Februarv 1994, and the other in subjectively in removing noise according
lows to show this. July/September 1995. to his time horizon. After each noise re-
iVe now need to look at whether noise duction, the chart can be inspected to see
2. There is a head &: shoulders pattern in
can be removed again from data which has whether sufficient noise has been removed
October/Sovember 1994.
already been ‘noise-reduced,’ and if so, and the appearance of the chart has been
does it continue to improve the data? Although these patterns are visible on improved.
Chart R3 shows the result of applying the original price line in chart Rl, there is Let us look at the results on other mar-
the noise reduction model to the data a no doubt that they are easier to pick out kets to see whether the same amount suc-
second time. This is done by applying the in the noise-reduced charts. One may con- cess can be achieved.
noise-reduction model to the data which tinue removing noise in this wal ,. ‘Each The charts above and on the following
has already had the noise reduced once. time the noise reduction calculation is per- page show:
The 2nd reduction factor comes out at formed on the previous set of noise-re-
Sl Dow original data
0.817 or 1.447 days. This means the chart duced data. At some stage, however, addi-
tional reductions will not remove addi- S2 Dow with one reduction
is constructed by taking a 1.447 exponen-
tial average of the 2.795 exponential aver- tional noise. The factors produced for the S3 Dow with two reductions
age of the close price. Once again, the three noise-reduced BAA charts are as fol- S4 Dow with three reductions
appearance of the chart is improved. The lows:
S5 Dow with four reductions
minor one-day corrections have been re- l 1st reduction factor of 0.527 equates to
moved, but the important minor trends a moving average of 2.795 days. S6 Dow with five reductions
are still in place. Once again however, the l 2nd reduction factor of 0.817 equates Si D&v with ten reductions
S8 Dow with twenty reductions

MTA JOURSAL l \\lnter - Spring I997 39


Table 1 right shows the factors required
to produce the reductions. Sotice how,
as the noise is reduced, the factor required
to reduce further noise becomes larger,
meaning the moving average is becoming
smaller. The first reduction requires a
2.663 moving average, whereas the 5th re-
duction only requires a 1.026 average. The
reason for this is that the line is becoming
smoother and so a shorter period moving
average is required to reduce further
noise. Notice too, that the factor increases
sharply up to the 5th reduction when it
reaches 0.987. It then increases slowlv over
the next 5 reductions until it reaches’1 .OOO
and remains at that level thereafter. A fac-
tor of 1.000 indicates a moving average of
1 and that no further smoothing is under-
taken.
The charts show that none of the re-
ductions have lost any of the essential pat-
terns in the price, which determine the
trend, and that there is virtually no lag.
Table 2 lists the number of day lag for
ever) reduction on the DOI\’ taking the
two turning points in January 1994 and
December 1994.
Table 2
Yumberof Kumberof DaysLag
Reductions l&l l&
1 1 1
2 1 1
3 1 1
1 1 1
1 1
To 1 1
In order to see how the reduction fac-
tors are distributed for a number of simi-
lar shares, two factors were extracted for
each constituent of the FT-SE 100 index.
That is to say, the model was used on the
original price to produce the 1st factor and
then on the smoothed data after applying
the 1st factor to produce the 2nd factor.
Table X in the Appendix A1 shows the re-
sult.
The 100 constituent shares are listed in
ascending order of the first factor. It
should be noted that the second factor is
Table 1 listed in the ascending order of the first
REDUCTION FACTORS factor and is, therefore, randomly distrib
uted. The third column shows the differ-
required for the following reductions
ence between the two factors.
1 3 3 4 5 1020
Fig. 1 on the next page shows the dis-
1 0.346 O.Y% 0.346 0.346 0.346 0.346 0.316 tribution of the 1st reduction factor for all
2 0.8330.833 0.8330.8330.8330.833 the 100 constituents from the low of 0.468
3 0.931 0.9310.9310.9310.931 to the high of 0.673. This should be com-
4 0.9700.9700.9700.9TO pared and contrasted with Fig. 2, which
shows the distribution of the 2nd reduc-
5 0.9870.98 0.98i
tion factor for the same 100 stocks. The
6 0.9940.994 factors do not increase evenly from stock
5 0.9980.998 #l to stock #lOO, like the 1st reduction
8 0.9980.998 chart, although the trend is generallv up
9 0.9990.999 as shown by the superimposed trend iine.
10 1.0001.000 This means that, just because a stock has a
higher 1st factor than another stock, it
11 1.000
does not follow that its 2nd factor will be
12 1.000 higher as well, although the tendency is
13 1.000 that it will be. This is confirmed bv the
l-1 1.000 varying differences between the 1s; and
15 1.000 2nd factors shown in Fig. 3. The superim-
1.000 posed trend line, however, shows that the
16
differences generally decrease as the 1st
1; 1.000
factor increases. The maximum difference
18 1.000 between the 1st and 2nd factor is .348 and
19 1.000 the minimum is ,195. Table 3 on page 42
20 1.000 shows the statisticalanalysisof the factors
and the difference between them.
MTAJOURN;U, l \\‘inter - Spring 1997
 Fig.1
Distribution of 1st Reduction Factorfor the FT-SE100 constituents

BOLT00
2
c
0550
9

{0500

04x)

0.4m

Fig.2
Distribution of 2nd Reduction Factorfor the FT-SE100 Constitutents

Sondm&c.ndmgOmrc41dFrtor
0600,

0550

0550

_a 0.840

LoS2o

ioWl

=07w

0.780

lE 0 740

Fig.3
Distribution of the differencesbetweenthe 1st & 2nd Reduction Factorfor the FT-SE100
Constituents

SondnAwndmgOrdwdl~Fvta
0.400
1
5 0.300

yo250

0.200
lb
1 ko
a
x
01m
 Table 3 2nd Factor Fnquency DIotttbWon Hlrtogmm
Factors 14

Ist &l Difference

Mean value 0.57767 0.84392 0.26625
Median value 0.5i8 0.8435 0.266
Mode value 0.573 O&9 0.262
Standard Del: 0.03483 0.01837 0.02607
Maximum \Blue 0.673 0.882 0.348
Slinimum Value 0.468 o.i92 0.195
Range 0.203 0.09 0.153
Iiurtosis 0.6044 -0.0101 1.3431
Skewness -0.0203 -0.16432 0.24864
Standard Error 0.00348 0.00184 0.00261
factor above.
95% Confidence 0.00691 0.00363 0.005li Table 4
It is also a bell shaped curve, and nega-
Let us start by looking at the analysis of tively skewed with a factor of -0.16432. The REDUCTION FACTOR
the first factor. The median is 0.578 and statistical analysis of the 2nd factor shows Ist 2nd
the mode is 0.573. The mean is almost an higher level of consistent!- than the 1st. World Indices
the same value as the median, differing b! The range at 0.09 is far smaller. The stan- Dow 0.546 0.834
only .00033. This indicates that the fac- dard deviation is also much smaller at S&P :oo 0.546 0.899
--
tors are all concentrated around the value 0.0183f. The mean and median are almost D.A!i 0.507 0.796
of 0.578. In fact the range between the identical. The 95% confidence level is half Hang Seng 0.509 O.i86
highest and lowest is only .0205. This that of the first factor. =Uso shown below Nikkei 0.499 0.813
shows a high level of consistency amongst is the Frequency Distribution Histogram FLSE Small Cap Indea 0.693 0.859
these data series, which are re- FI-SE 230 0.643 0.838
lated to one another because FYI-SE330 0.577 0.830
they are the top 100 shares in Dtthknnco bHwomnlstL 2nd Factor FI-SE 100 0.560 0.824
Fnquncy Dlatributlon tilstogmm FI EuroTrack Index
the U.K. The realitv that the 0.581 0.830
factors are so simila; indicates UK Equities
that the stocks have a similar Allied Domeq 0.535 0.838
amount of noise. .Zrgyll 0.573 0.863
The 95% confidence inter- XDA 0.529 0.858
val is 0.00691, which means that British Airports 0.528 0.818
we can be 95% confident that British Ainvavs 0.588 0.8.%
the factor will occur between British Telec&n 0.56? 0.833
0.58G and 0.5iO5. Disons 0.530 o.soi
Before looking at the 2nd Hanson Trust 0.511 0.839
factor, let us look at the 1st Fac- ICI 0.553 0.832
tor Frequency Distribution His- A Marks 8: Spencer 0.581 0.814
togram below. As expected it is bell shaped of the difference between the two factors. PowerGen 0.6i4 0.869
and slightly skewed to the left with a nega- The statistical analysis and the histo- Redland 035i 0.831
tive skewnes factor of -0.0203. gram show that the difference between the Pearson Group 0.5i8 0.836
two factors is fairly constant. Smithkline Beecharn 0.56 OA47
Having looked at the con- Schroeders 0.%2 0.829
la1 Factor Fmquncy Dlntribution Hletogmm sistency of the model across Thorn EM 0.633 0.833
similar instruments, such as Amstrad 0.603 0.883
the FT-SE 100 constituents, Lucas Industries 0.531 0.81i
we need to see how it per- Trafalgar House 0.545 O.Sli
forms on other markets. T\vo British Biotech 0.687 0.86i
reductions were conducted Brake Brothers 0.616 0.856
on a variety of markets. Table Croda International 0.591 0.848
3 shows the 1st and 2nd re- Menzies(Ji 0.582 0.831
duction factors obtained for Laporte 0.48i 0.8Oi
\Vorld Indices, a selection of IRlI O.jiO ON8
UK equities, UK Futures, US Harrison & Crossfield 0.48i 0.847
Futures and Commodities R-SE 100 Futures
and a selection of Intrada) FT-SE100 Dee 1994 0.589 0.847
hourlv data. Notice that the FT-SE100 Mar 1995 0.378 0.843
This should be compared to the Fre- DO\V and S&P 500 are the same. ET-SE100Jun 1993 0.383 0.850
quency Distribution Histogram of the 2nd FT-SE100 Sep 1995 0.583 0.849
ET-SE100 Dee 1995 0.585 0.846

42
MTA JOURNAL l II-inter - Spring 1997
FIX 100Mar 1996 0.582 0.810 vantages of the least squares
US Futures method? Is it better than
Corn Mar 1996 0.593 0.814 ordinary moving averages
SoybeansMar 1996 0.592 0.856 or filtered wave charts?
\\‘heat Mar 1996 0.594 0.815 Let us compare the
Live Cattle Apr 1996 0.592 0.836 method with ordinarj
Pork Bellies Mar 1996 OX 0.8i6 simple moving averages.
S&P 500 Mar 1996 0.586 0.830 1. The least squares
Nikkei Mar 1996 0.594 0.845 method allows for fractional
British Pound Mar 1996 0.598 0.836 periods, which simple mov-
D Marl, Mar 1996 0.592 0.860 ing averages do not. Even
EuroDollar Mar 1996 0.33; 0.834 if exponential averages were
Coffeehlar 1996 0.599 0.8i6 used subjectively, the analyst
CocoaMar 1996 0.576 0.8ii would not know lvhat frac-
Sugar Mar 1996 0.596 0.837 tional period to use.
Orange Juice hlar 1996 0.579 0.846 2. The least squares
Crude Light Mar 1996 0.590 0.882 method is objective. The
Heating Oil Mar 1996 0.586 0.8i4 exponential factor is ob-
Gold .\pr 1996 0.580 0.815 tained by using back histo?
Gold Feb 1996 0.66i 0.865 to calculate the smoothing
Gold Dee 1995 0.669 0.839 factor, whereas with ordi-
CRB Index hlar 1996 0.615 0.841 nay moving ayerages, the
Intraday analrst must decide on the
DON 1 hour 0.429 0.822 moving-average period b!
FI-SE 100 1 hour 0.494 0.802 inspection. However, the
LIFFE Long Gilt lmin 0.4i9 0.m least squares method does
Mied Domeq 1 hour 0.383 0.i33 allow the analyst to be sub-
ASDA 1 hour 0.3s 0.i30 jective, by re-running the
Brit..%rports 1 hour 0.307 0.20 noise reduction algorithm
Brit..%nvays1 hour 0.416 O.i66 on the already noise-re-
British Teiecom1 hour 0.436 0.89 duced data until such time
Disons 1 hour 0.529 o.i99 as he is satisfied with the re-
Under the heading UK equities, al- sultant chart, or he can keep
The few UK market indices provide an running it until the reduction factor
interesting insight into the noise reduction though there is a mix of Fl-SE 100 con-
stituents and lesser shares, it is impossible equals 1.O.
process. The factor for the FT-SE 100 in-
to say which is which bp simply looking at 3. There is less lag with the least squares
dex is lowest, next is ET-SE 350, then the
the factors. In fact the first 16 on the list method, especially if more than one
FT-SE 250, then FT-SE Small cap index.
are the constituents and rest are not. This level of reduction’ is undertaken. In
This may be explained in terms of the
means that the capitalisation and trad- order to remove additional noise with
smoothness of the data. Charts S9, SlO,
abiliw of the share has no visible effect of ordinar!: averages, the period of the
Sll and S12 show the original data for FT-
the reduction factors. average 1s increased, whereas with the
SE Small Cap, FT-SE 250, FT-SE 350 and
The next heading in the table is FT-SE least squares method, additional noise
FT-SE 100 indices respectively. By simple
100 Futures. \‘arious contracts were inves- is removed by applying a varying short-
inspection it is easy to see that the FT-SE
tigated. The factors are slightly higher term average to data which has alreadr
Small Cap is the smoothest, the next is the
FT-SE 250, then the FT-SE 350 and finall) than those for shares and spot indices. had its noise reduced.
Various US Futures contracts were also
the FT-SE 100 is the noisiest. This is no
investigated. As with the FT-SE 100 future,
surprise because we have already seen that Applying Traditional
the CS futures are generally higher.
the second reduction, which is conducted Techniques
on smoother data, is always higher than Because the least squares method can
be used on any time series - daily weekl! Having proposed and discussed the
the first. Data smoothness can also be mea- least squares method, we now need to see
as well as intraday data - a number of re-
sured in terms of volatility measured by the whether traditional Technical Analysis
ductions were performed on various
annualised standard deviation. The techniques can be applied to the nois&e-
intraday data sets. The factors for howl!
annualised standard deviation of the four duced data.
equities, .Yllied Domeq, ASDh, British Air-
data setz are as follows:
ports, British ;2irway, British Telecom and Moving Averages
n-SE 100 11.~14%
Dixons are all lower than the equivalent Chart Tl shows the supermarket chain
FI-SE 330 10.386% daily factors, indicating a greater amount XSDX (ASSD) with a 20-day moving aver-
F-r-SE230 7.9iO% of noise in hourly data. The hourly DOM age. The 20-day tracks the price well, with
FT-SESmall Cap &9i5% and FT-SE 100 factors are also lower than a number of false penetrations. Chart T2
Therefore, the smoother, less noisy less the daily shows a 1st noise reduction of XSSD with
volatile the data, the higher the reduction So, what are the advantages and disad- a 20-dav average. Remember that this is a
factor.

MTA JOURUL l \\inter - Spring 1997

 20-dav average of the noise-reduced data
and not of the original data. The result is
that the chart signals are improved. The
line is smoother and some of the minor
whipsaws are removed. However, the ‘buy’
and ‘sell’ signals given by the moving aver-
age, still occur on the same day. Charts
T3 & T4 show the result of imposing a 20-
da? moving average on the 2nd and 3rd
noise reductions respectively As more
noise is removed, the false signals disap-
pear completely albeit at the expense of a
slight signal lag. This is because the noise
reduction model reduces the range of the
price and so sharp movements are
‘rounded off.’ For man!; these more reli-
able signals are of great benefit, because
of the additional confidence obtained by
avoiding false signals.
Oscillators
M’elles 1Vilder’s RSI’ oscillator is one of
the world’s most popular momentum in-
dicators, so let us look at whether its read-
ability can be increased. Chart Ul shows
the &iness (GUN), with an original 14
day RSI (chart c‘2) right. Chart U3 shows
a 14-day RSI of data from the 1st noise re-
duction and Chart U4 shows a 14-day RSI
44
of data from the 2nd noise
reduction.
The first point to notice
is that there is no lag with ei-
ther the 1st or 2nd noise-re-
duced RSI lines. Further-
more, none of the original
RSI pattern is lost. The es-
sential RSI patterns and
trends, although smoother,
are still visible. But what is
important, is that the diver-
gences are still there and in
most cases they are im-
proved. Look at the lower
price lows that occurred in bl, ,, ,” ,~,“, )p:,. ,
December, .Januarv and I
March, and the high& lows in the origi- The price high in September 1995 cre-
nal RSI (chart Ul) marked with line AB. ates a problem. Chart U2, the original RSI,
All the noise-reduced RSI’s show this di- shows confirmation rather than direr-
vergence as well, but it is only marginally gence - marked with line EF. Chart U3,
clearer. the 1st noise-reduced RSI, shows marginal
However, the important price high in divergence, but the 2nd noise-reduced
Januaq 1994 hardly shows any divergence RSI, chart U4 shows divergence ver!
on the original RSI line-marked with line clearlv.
CD. The noise-reduced chart U3 on the The next aspect to note about the noise-
other hand shows it very clearly and is reduced RSI’s is that they extend to greater
shown even more decis&elv by ;he 2nd extremes, making it much easier to pick
noise-reduced line, chart U4. the traditional turns above 70 and below
MTA JOLRSAL l \\lnter - Spring1995
 an OBV drawn using 1st 12193 0.5;; 0.838 0.535 0.816
stage noise-reduced data. 06,i94 0.53: 0.831 0.534 0.807
This is done by reducing the 12194 0.538 0.8?6 0.553 0.825
noise in the price data and 06/93 0.544 0.8?6 0.542 0.841
then using the noise re-
12/95 0.558 0.825 0.542 0.837
duced data to determine
whether the noise-reduced The summary of the results for the FT-SE
price is up or down from the 100 index in table 5 are shown in table 6.
previous day. The smoother
data will result in more con- Table 6
secutive days in the same di-
rection. Tke resultant OB\ FACTORS
chart is entirely different. It IsI ?nd
shows marginal accumula- hlean Factor 0.52X 0.8275
tion between July 1994 and hledian Factor 0.52i 0.826
the beginning of 1995, dur- hlode Factor 0.52; 0.831
ing which time there was a Std Dedation 0.0191 0.01617
marginal improvement in LowestFactor 0.492 0.869
the price. However, the Highest Factor 0.562 0.805
noise-reduced OBV started Hi/Lo Range o.oi 0.064
to decline sharply during ConfidenceLevel 95% 0.00869 O.OOi36
1995, in line with the actual
price. There is a slight im- and for the DOF\’ in table 7.
provement in the behaviour
of the OB\’ when it is drawn Table 7
using the 2nd stage noise-re-
duced data, chart \‘4. FACTORS
We have looked at a num- & ?nd
ber of examples of noise-re- Mean Factor 0.5136 0.830
duced data using the least Median Factor 0.322 0.833
squares technique. It is also Mode Factor 0.342 0.847
important to see if the re- Std Deviation 0.032% 0.01398
duction factor changes over LowestFactor 0.353 0.847
30. The range of the original RSI is from time. Table 5 shows the 1st and 2nd re- Highest Factor 0.455 0.799
17 to 86, the 1st reduction is from 10 to 94 duction factors for 600 days of the FT-SE Hi/Lo Range 0.098 0.048
and the second reduction is from 7 to 95. 100 and DO1V indices, taken at 6 monthl! ConfidenceLevel 95% 0.01482 0.00636
It is important to note that an RSI intervals from December 1984 to Decem-
drawn using noise-reduced data is not the ber 1995. The tables show that the factors over a
same as drawing a moving average on origi- ten year period are consistent for both the
nal RSI data. Charts U5 and U6 show a 3- Table 5 DOM’ and the FT-SE 100 index. Looking
and 6day exponential of the 14day RX. FT-SE100 DOW at the 1st factors first, we can see that the
In both cases the range is reduced rather 600 day 1st 2nd 1st 2nd 1st factor for the K-SE 100 has the same
than increased. Although some of the di- LlJ&o Reduction Factors mean, median and mode of 0.527, with a
vergences show, the important high in Sep 12183 0.541 0.841 0.488 0.847 very low standard deviation of 0.00191 and
tember 1995 is shown as a confirmation 06/86 0.562 0.869 O.jOi 0.838 confidence level of 0.00869. The range is
in both charts. only 0.05. The 1st factor for the DOk\’ is
12/86 0.542 0.861 0.518 0.844
Volume Indicators 06/87 0.527 0.831 0.548 0.833 marginally less consistent. Its mean, me-
Can noise reduction improve volume dian and mode are each different. Its stan-
12187 0.515 0.818 0.46i 0.847
based indicators like Granville’s On-Bal- dard deviation and 95% confidence level
06/88 0.511 0.824 0.471 0.845 are both higher than those of the FT-SE
ance i’olume (OBV) ‘? 12/88 0.506 0.817 0.465 0.844
Chart \‘l shows the price of United Bis- 100.
06,‘89 0.513 0.828 0.469 0.841 The consistency measures show an al-
cuits (IBIS) with a regular OB\‘shown in
12/89 0.492 0.820 0.4% 0.829 most identical con$istencv for the 2nd fac-
chartV2. The uptrend of OBV chart shows
general accumulation of the share over the 06/90 0.507 0.839 0.496 O.i99 tors of the DON’and FT-SE 100. Although
period under consideration, but generally 12/90 0.539 0.831 0.512 0.818 their means are different, their standard
during this time, the price was in a down 06/91 0.514 0.805 0.522 0.815 deviations and confidence levels are simi-
trend. Particularly disturbing is the period 12191 0.509 0.805 0.533 0.824 lar.
behveen July 19$5 and November 1995, 06/92 0.523 0.80T 0.549 0.838 This consistency of both factors over
when the OB\’ showed strong accumula- 12192 0.527 0.815 0.544 0.829 the lo-year period includes factors ob-
tion, during a strong price decline - nor- tained during the sharp correction in
06/93 0.523 0.820 0.53; 0.81i
mally a bullish analysis. Chart \‘3 shows 1987. Notice that when the factor is ob
tained from data which includes the 1987

MTA JOURSAL l \Cinter - Spring I99i 45

 correction period, the factor is lower, in-
dicating that a greater moving-average
period is required to smooth the data.
Considering the sharpness of the correc-
tion, however, it is remarkable that the dif-
ference is so slight.
Although the statistics show that the
reduction factors are fairly constant over
time, the amount of variance that is
present is to be expected, as the period
under consideration has a number of com-
pletely different trends - from sharp cor-
rections, to long consolidations, to long
uptrends.
Conclusion
The assumption behind this article is
that noise is the enemy of the Technical
Analyst. On the other’hand, it has been
acknowledged that some Technical Analy-
sis disciplines, such as Elliott U’ave Anal!-
sis, do not favour tampering with the data
to remove noise, because ‘noise’ is impor-
tant to the analysis method. It has been
shown that it is difficult to eliminate noise
from data, if the decision as to what con-
stitutes noise is subjective. If noise cannot
be defined in absolute terms, it cannot be
eliminated. It has, however, been shown
above that noise can be reduced to such
an extent that it can significantly improve
trading signals. Traditional methods of
noise reduction, namely moving averages,
filtered waves and point & figure charts
were discussed and evaluated. Although
they are all able to reduce noise, it is felt
that they are too subjective in their opera-
tion.
The Least Squares Noise Reduction
Method proposed and eraluated in this
article does give better results than these
purely subjective methods. Part of the rea-
son is that there is a mixture of objectiviq
as well as subjectivity in the technique. The
‘run’ through the Model to achieve what
has been called the first noise reduction
factor is objective. Through calculation
the Model produces an exponential fac-
tor, which is then used to draw a new
smoothed line. The analyst is then able to
inspect the new line according to indi-
vidual subjective criteria and has the op
portunity of deciding whether sufficient
noise has been removed from the data. If
so, the line may then be used to replace
the original data and normal Technical
Analytical techniques may be employed as
if it was the original data itself. If not, more
noise may be removed using the objective
technique again and again until the ana-
lyst is satisfied with the result.
46
It has been shown, however, that there
is an effective limit to the number of times
that the data can be passed through the
model, as the reduction factor reaches 1 .O
after about 3 ‘runs.’ This is a major advan-
tage of this method over all other meth-
ods, as a factor of 1.0 indicates that the
forecast matches the price, suggesting that
all the noise has been removed. But this
seems to contradict the statement made
at the beginning of this article, that noise
cannot be removed because it cannot be
defined. However, if we now define noise
as that part of the data which prevents the
next period’s price from being forecast b!
the Least Squares Noise Reduction
method, then we can pronounce that all
the noise has been removed when the re-
duction factor reaches 1 .O.
Another benefit of this technique is that
unlike normal smoothing techniques
where a larger average period is used in
order to remove additional noise, the least
squares method uses varying, very short-
term averages which are applied to previ-
ousl~ smoothed data. This incremental
technique appears to give better results as
it alloivs a pause for inspection between
each noise reduction. It also preserves the
essential patterns in the data.
We have seen that the reduction factor
increases as the data becomes smoother,
indicating that a shorter-term average is
required to reduce further noise. This
increase continues until the reduction fac-
tor reaches 1 .O.
It has also been seen that if the chart of
the original data appears smoother to the
eye, the factor produced b? the least
squares algorithm is higher. This was
shown by comparing the noise reduction
factors and charts of various UK market
capitalisation indices.
As the ‘mood’ of markets change from
one year to the next, it was significant to
see that over time the reduction factors
change yen little. This was illustrated us-
ing the FT-SE 100 and the DOM’ index.
The title of this article asked whether
noise can be eliminated, and if so, at what
cost. It has already been stated that noise
elimination is possible if noise is defined
as that part of the data which prevents the
next period’s price from being forecast b!
this technique. But what of the cost? The
only cost is the turning point lag that is
present in any averaging technique, which
the Least Squares Noise Reduction
method is. However, the amount of lag is
so small that it should not be regarded as
a negative factor. In fact, a certain amount
of lag may be beneficial because although
MTAJOUUUL l \\‘inter - Spring 1997
the signals are delayed, their reliabilie is
increased.
It is, therefore, concluded that the pro-
posed Least Squares Noise Reduction
method proposed and outlined in this ar-
ticle is superior to the more traditional
methods of smoothing data.
Finally this article has merely scratched
the surface of noise reduction. Its purpose
however, is to present a simple objective
method of reducing noise to those Tech-
nical Analysts who do not wish to be in-
volved wit< high level mathematical tech-
niques. However, further reading is listed
for those who wish to delve deeper into
the subject of communication theov and
signal noise.
References and Further
Reading
Carlson, A. B., Communication Systems,
An Introduction to Siznals and N’oise in
Electrical Communication, McGraw-Hill
Inc., 1953.
Frost, A. J. & Prechter, R. R., Elliott LVave
Princinle - Kev to Stock Market Profits,
New Classics Library Inc., New York, 1978
Granville, J., New Key to Stock Market Prof-
& Prentice Hall, Englewood Cliffs, NJ.,
1963.
Harris, R. U’. gCLedwidge, T. J., Introduc-
tion to Noise Analysis, Pion Limited, Lon-
don, 1971.
Hurst, J. -II., The Profit Magic of Stock
Transaction Timing, Prentice Hall Inc,
Englewood Cliffs, NJ., 1970.
Kaufman, P.J., The Sew Commodity Trad-
inc Systems and Methods, John iVile? 8:
Sons Inc, New York, 1987.
McLaren, L\‘., Gann Made Easv - How to
Trade Using- the methods of 1V.D. Gann,
Gann Theory Publishing Company Cor-
pus Christi, Texas, 1986
Murphy J. J., Technical Analvsis of the Fu-
tures llarkets, New York Institute of Fi-
nance, New York, 1986.
Pierce, J. R., Symbols. Siwals and Noise,
Hutchinson S: Co. Ltd., London, 1962
Pike, E. R. & Lugiato, L. A., Chaos, Soise
and Fractals, Adam Hilger, Bristol, 1987.
Pring, 11. J., Technical Analvsis Exnlained,
McGraw Hill Inc, New York, 1983.
Spiegel, M. R., Theory and Problems of
Statistics, McGraw-Hill Inc., 1961
Tufte, E. J., The Visual Disnlav of Ouanti- 49 Burmah O.>ii 0.841 0.264
Appendix A
tative Information, Graphics Press, 3 Commercial Vnion 0.358 0.846 0.268
Cheshire, Connecticut, 1983. 1st 2nd Diff-
1 Pearson O.jiS 0.836 0.2%
4 DescriDtioll FactorFactor erence
\Vainstein, L. A. & Zubakov, Y. D., Extrac- ? BP 03i9 0.82 0.293
tion of Signals from Noise, Prentice Hall, 1 Guardian Roval Exchange 0.168 0.812 0.344 3 Kingfisher O.ji9 0.828 0.249
Inc., Englewood Cliffs, NJ., 1962 National Grid 0.509 O.iYP 0.283 0.5i9 0.841 0.262
4 Tom!&
M%eelan, A., Study HelDs in Point & Fit- Hanson 0.511 0.859 0.348 5 Cable 8: Wireless 0.5i9 0.834 0.2i5
we Techniaue, Morgan, Rogers &Roberts Rolls Royce 0.512 0.822 0.310 6 Mark 8: Spencer 0.581 0.814 0.233
Inc., 1954 0324 0.830 0.306
km Alliance 7 Reckitt 8: Colman 0.581 0.826 0.245
M’ilder, I\‘. J., New ConceDts in Technical Killiams Holdings 0.328 0.821 0.293 8 PkO 0.581 0.846 0.265
Trading-s Systems, Trend Research, B,L-1 0.328 0.818 0.290 9 Burton Group 0.583 0.841 0.233
Geensboro S.C., 19%.
Lloyds Bank 0.29 0.813 0.284 ‘0 Barclays 0.583 0.848 0.265
ilhnnacott, T. H. 8r Wonnacott R. J., b .&da 0.29 0.898 0.329 11 General Accident 0.33 0.839 0.256
troducton Statistics, John M’ilev B Sons,
0 Disons 0.530 0.8Oi 0.2ii 12 Reed International 0.583 0.845 0.262
1977
1 Yodaphone 0.532 0.836 0.304 13 RMC Group 0.586 0.836 0.230
2 Allied Domeq 0.535 0.838 0.303 i4 Lnilever 035 0.844 0.25i
Footnotes 0.535 0.799 0.264
3 Orange ij Standard Chartered ON 0.824 0.237
1. Carlson, A. B., Communication Svs- 4 Guiness 0.535 0.822 0.28i i6 British Airvavs 0.588 0.853 0.26i
terns, An Introduction to Signals and
Noise in Electrical Communication, 5 Bank of Scotland 0.536 0.832 0.296 ii Sest 0.589 0.834 0.245
McGraw-Hill Inc., 1975, 4. 6 Cadbuy 0.342 0.815 0.273 j8 Sational Power 0.589 0.841 0.232
li Glaxo 0.54i 0.838 0.?91 i9 British Steel 0.591 0.842 0.!?51
2. Filtered M’aves were introduced b\
Arthur Merrill over 20 years ago and 18 Rank 0.54i 0.851 0.304 i0 Land Securities 0.591 0.838 0.247
have been duplicated and renamed b) 19 Ladbroke 0.349 0.851 0.302 il RTZ 0.591 0.850 O.l59
other analysts. !O Abbey Kational 0.550 0.831 0.281 i? GEC 0.592 0.860 0.268
3. \Vilder, M’. J., New Concepts in Tech- !l Schroeders 0.552 0.8'29 0.2ii 73 SatWest Bank 0.594 0.860 0.266
nical Tradings &terns, Trend Re- 22 ICI 0.553 0.852 0.299 i-l Scottish Power 0.593 0.846 0.251
search, Geensboro N.C., 1978 13 Royal Insurance 03 0.824 OX1 75 Rentokill 0.596 0.840 0.244
4. Although f = 2/ntl is the most com- 24 Pikington 0.554 0.838 0.284 i6 Prudential 0.600 0.852 0.232
mon translation formula, some ana- “5 Zeneca 0.554 0.832 0.258 0.601 0.871 0.270
ii Sainsbun
lystsprefer to usef = 2/n. However,
26 Redland O.%i 0.831 0.274 i8 Cnited Kews & Sledia 0.602 0.878 0.276
this yields a factor 1 when the period
n = 2. It isfor this reasonthat the f = 2i HSBC O.%$ 0.824 0.266 79 Reuters 0.603 0.878 0.275
2/ntl uses a divisor of ntl. 28 Sebe 0.560 0.822 0.26? 80 \\“nitbread 0.604 0.839 0.2%
5. It is possiblethat over wide-ranging 29 Blue Circle 0.560 0.835 0.275 81 Enterprise Oil 0.604 0.868 0.264
data, using the difference between the 30 Shell 0.561 0.845 0.284 82 BOG 0.608 0.812 0.244
forecastand the actual price will tend 31 British Telecom 0.562 0.835 0.273 83 31 0.609 0.839 0.230
to distort the results. Instead there-
32 Tesco 0.566 0.839 0.2i3 84 Cookson 0.609 0.833 0.244
fore, when conducting the process
33 Scottish k Yewcastle 0.567 0.836 0.269 85 Smith & Sephew 0.610 0.851 0.241
over a long time series,it is better to
normalise the difference by dividing 34 Granada 0369 0.834 0.263 86 BTR 0.61? 0.864 0.22
it by the price. The difference between 35 TI Group 0.569 0.8% 0.258 8i Wolsle) 0.613 0.839 0.246
these two methods is shown in Appen- 0.30 0.843 0.2i3
36 Boots 88 Great Lkersal Stores 0.615 0.839 0.244
dix C.
3i Grand Sletropolitan 03io 0.845 0.275 89 Southern Electric 0.620 OX9 0.239
6. ibid 38 Smiths Industries O.ji? 0.851 0.279 90 Argos 0.622 0.859 0.237
7. Granville, J., NewKev to Stock Markel 39 Tate 8: Lyle O.ji? 0.839 0.26; 91 Legal & General 0.623 0.832 0.229
Profits, Prentice Hall, Englewood 40 AB Foods 0.573 0.816 0.241 92 Royal Bank of Scotland 0.626 0.871 0.245
Cliffs, SJ., 1963. 0.5i3 0.835 0.262
41 Bat Industries 93 United Utilities 0.628 0.882 0.23
42 Argyll 0.373 0.863 0.29C 94 British SkyBroadcasting 0.632 0.849 0.217
43 Courtauld 0.373 0.843 0.2X 95 British Aerospace 0.638 0.865 0.25
44 Lasmo 0.573 0.871 O.?9t 96 Sevem Trent 0.639 0.879 0.240
45 Thames Water o.jij 0.85; 0.281 '5 Carlton Communications 0.649 0.877 0.2?8
46 Smithkline Beecham 0.576 0.847 0.?51 98 GKK 0.651 0.862 0.211
4i Bass 0.5;6 0.850 OX- 99 Thorn EM 0.653 0.853 O.?OO
48 British Gas 0.576 0.838 0.261 100 Pore-ergen 0.673 0.868 0.195

MTA JOURML * \Vinter - Spring1997

 Appendix B Appendix C
1. The exponential average in period t E, =fP, + (1 -jE,., DOW 1952 to 1996
where Factor Sum Sqr Sum Sorm Sar
Initial condition is E, = P, 0.100 6iO3328.59 2.i326
ECis exponential average in period t 0.200 4063988.8i 1.5956
P, is the Price in period t 0.300 3270494.T2 1.2449
El, is exponential average in period t-l 0.400 2955i10.88 1.0972
f is the exponential smoothing factor 0.500 2854255.63 1.0402
f= 2 0.519 2851566.21 1.0362
n tl where n is the moving ayerage period 0.520 2851553.64 1.0361 <- least sumsqr
0.521 2851553.i6 1.0359 <- least sumsqr
2. The trend of the average in period t T,=f(E,- Et.,) +U -JT,.,
0.522 2851566.55 1.0358
where 0.530 2832121.8i 1.0348
Initial condition is T, = 0 0.540 2833939.02 1.0340
(El- E[ ,) is the difference behceen the exponential average 0.550 2856971.93 1.033i <- least sum norm sqr
in period t and t-l 0.560 2861214.i6 1.0338
T,~, is the trend in period t-l 0.600 2890004.~4 1.0390
3. The forecast for period ttl F,tl=EltIT, o.ioo 3044272.50 1.0822
f 0.800 3327036.84 1.169i
4. Difference between forecast price 8r actual price dt = F, - P, 0.900 3772222.23 1.3097
where
PI is the actual price in period t DOW 600 Days to Dee 87
FI is the forecast price for period t Factor Sum Sqr Sum Norm Sar
0.1 1773714.08 0.48t3
5. Squared difference D= ; dt’ 0.2 1056300.61 0.2914
t=l 0.3 848915.75 0.2335
where 0.4 i83321.24 0.2112
n is the number of data points 0.466 774216.31 0.2113
d,?is the square of the difference in period t 0.46; i’i4215.66 0.2112 <- leastsum sqr 8:
6. Find the least squared difference by trial and error. leastsum norm sqr
0.468 ii4218.59 0.2112 <- least snm norm sqr
0.469 iil225.10 0.2112 <- least sum norm sqr
0.4i 774235.16 0.2112 <- least sum norm sqr
0.48 5iG2i.U 0.2113
0.5 776109.10 0.2117
0.6 801328.02 0.2189
0.i 852832.12 0.2338
0.8 933323.93 0.2567
0.9 1051332.iO 0.2896

When a long time series is studied, such as the DON’ from 1952
to 1996, the factor that produces the least sum of the squared error
is different from the factor that produces the least sum of the
normalised squared error. However, when a shorter time series is
studied, such as the 600 day of the DO\V, the factors are the same.

Jeremy J. A. du Plessis, CMT

Jeremy; du Plessis is the Managing Director of ISDEXM
Research Limited in the United Kingdom, specialising in tech-
nical analysis software. He is responsible for program specifi-
cation and development as well as indicator research. He has
used and researched technical analysis for over 17 years.

48 MTA JOURNAL l \Vinter - Spring 1997

 Sector Analysis Using New Highs and New lows
Introduction
Sew High and A&o Low data are widely
used in analyzing the stock market on a tech&
cal basis. New Highs and Xew Lows, vnurh
like advances and derlines, illustrate the leuel
ofparticipation in the market, and are a guide
to internal strength or weakness of the market.
In fart, lUu~ High/Xew Low data are often ron-
sidered supevior to advance/decline data because
to register on the Xew High/Xew Low list, a
stork usua@ has to travel far&; whereas a
stock on4 has to be up or down l/8 to reg’ster
as an advancing or declining issue. Thus, in-
ternal strength is accompanied bJ an ex$and-
ing list of X-w Highs, while internal weakness
is accovnpanied by an expanding list of Xtw
Lo7us.
This paper will explore the use of Sector Ah
High and Xzu Low data for spotting changes
in sectors of the market. I use some divergence
analysis, movnentum and/or relative strength
analysis in an attempt to quantijj bulJ and sell
signals. I belieoe this study is pioneering and
gives technicians another tool for analyzing the
vnarkets.
Divergence Analysis
Turning points in the markets are of-
ten led bv changes in various momentum
indicators including rate of change analy-
sis, relative strength, advance/decline
measures and, of course, New High minus
New Low measures. New High minus New
Low oriented indicators may prol-ide bet-
ter entry and exit points to the stock mar-
ket because, in my opinion, they hare a
tendency to lead the broad market aver-
ages. For, example, as a bull market ma-
tures, a majori? of stocks will stop posting
New Highs, while a narrow list of stocks
continues to carry the market averages
and/or sector indices to a higher level.
Similarly, when a momentum indicator
diverges, we receive preliminarv warning
of a possible trend change. A divergence
occurs when a price index makes a high
unaccompanied by an underlying indica-
tor. A divergence also occurs when a price
index makes a low and is unaccompanied
by an underlying indicator. The first is a
bearish divergence, while the latter is a
bullish divergence. Divergence analysis
will be used in this paper to some extent
with respect to New Highs and New Lows.
FrankTeixeira,CMT
Divergence analysis is an important ele-
ment of technical analysis, but interpreta-
tion sometimes involves a high degree of
subjectivity.
Momentum & Relative
Strength
There are two way of looking at mo-
mentum: as a measure of rate of change
and as a measure of internal market vital-
ity Rate of change is more suitable for
measuring a price average, while certain
measures of internal strength are better
applied to monitoring market indicators.
One of the tools used frequently in
technical analysis is relative strength. Rela-
tive strength measures how well a stock
and/or market is performing relative to
another stock and/or market. A rising
relative strength ratio implies improving
performance, while a declining relative
strength ratio implies weakening perfor-
mance. In this paper, I use this concept of
“relative momentum” to generate buy and
sell signals using Sector New Highs and
Sew Lows. This, to my knowledge, will be
the first time relative strength has been
used in conjunction with New High/New
Low data.
Sew High/New Low data have usually
been used as a momentum measure. In
other words, as a market moves higher,
New Highs should expand and New Lows
should contract. If a market makes a new
high and the Sew High list contracts, this
is regarded as a sign that internal momen-
tum is slowing. The rate at which the New
High list expands is also critical in deter-
mining a market’s internal strength. Dur-
ing the initial stages of an advance, New
Highs should expand rapidly. The longer
the duration of the expansion in h’ew
Highs, the longer or more durable the
rally.
The Sew High/New Low list offers
manl- possibilities for analysis. Investor’s
Business Dailv’s Sew Hig</New Low list
will be used as the source of this analysis.
Sector Analysis Using New
High & New low Data
Investor’s Business Daily divided its New
High/New Low list into various sectors (30
in all) starting on July 26, 1991. The lim-
MTA JOURNAL l \\‘inter - Spring 1997
ited histon is a shortcoming, but it is still
enough to draw some reasonable conclu-
sions. Four sectors will be analyzed: Banks,
Energy Medicals, and Utilities.
The form of this analysis is twofold.
First, a lo-day moving average was taken
of the Net New Highs for each sector (this
will be referred to as the NNH through-
out the paper). Divergence analysis is then
used to gain some insight. Admittedly the
insight is limited due to the fact that di-
vergence analysis tends to be more subjec-
tive than objective, but the NNH was still
useful in some cases.
Second, I introduce a new term called
the RSH, which is the relative strength of
a sector’s New Highs. It is calculated b\
dividing the number of Sew Highs in a
sector b!- the number of New Highs in the
market. X lo-day moving average of the
RSH is then taken and used for the anal?-
sis.
Lastly, I also introduce another term
called the RWL, which is a relative weak-
ness of the New Lows in a sector relative
to the total New Lows in the market. h lo-
day moving average of the RM’L is then
taken and used for the analysis.
The tenn “relative strength” in the RSH
refers to a rising number of New Highs in
a sector relative to the total number of New
Highs in the market. The term “relative
weakness” in the RM’L refers to a rising
number of New Lows in a sector relative
to the total number of New Lows in the
market. The RSH and the RMZ more ac-
curately measure the percentage of New
Highs or New Lows in a particular sector
to the total number of New Highs or Nev
Lows in the market.
The RSH is used to generate the by
and sell signals, while the RF11 is used to
gauge the degree of weakness in a sector.
The RSH rises quickly when a sector is
strong and descends quickly when a sec-
tor corrects. This happens because stocks
of a particular group tend to rally and cor-
rect together. Corrections are healthv as
long as New Lows do not expand to any
great degree.
The four sectors chosen are presented
with a chart of the sector index, a lo-da\
moving average of the sector Net Ne&
Highs (NYH) , a lo-day moving average of
the sector New Highs relative to the Mar-
49
 ket New Highs (RSH), and a lo-day mov- and offers more satisfying proof of sec-
ing average of the sector New Lows rela- tor strength.
tive to the Market New Lows (RUT). The 5. The 4 parameter of the RSH was del-el-
parameters used for the studies are as fol- oped by simply rounding the 3.33
lows: benchmark percentage up to 4. Round-
I The NNH will be used mostly for sub- ing up enables the investor to sell be-
jective divergence analysis. The diver- fore the sector drops under 3.33, to re-
gences in some instances precede bu! tain a better portion of the profits or
and sell signals given by the RSH. to limit the losses.
I The RSH gives a trading buy signal b) 2. The 15 for the aggressive trades was
moving to or above 7. In other words, chosen because 15% of the total num-
when 7% of all Sew Highs in the past ber of New Highs is better than four
10 days on average belong to a particu- times the 3.33 benchmark percentage
lar sector, a buy signal is given. A trad- and is considered very strong momen-
ing sell signal is triggered when the tum. Once that peak number drops b!
RSH mo\-es to or under 4 (4%) after half, enough of the momentum has
being at or above 7. been exhausted for the purpose of ag-
w The RMZ will trigger an alert when it gressive trading.
moves above 10 or when 10% of all the 5. The RU’L of 10 was selected simply as a
New Lows in the past 10 days on ayer- round number made up of 3/30ths of
age belong to a particular sector. The the sectors. Ten percent is significant
R\$X above 10, however, does not su- weakness for any particular sector and
persede the RSH in the buy mode. The is about 3 times the 3.33 benchmark
RU’L above 10 does mean that the risk percentage.
in a sector is rising and that a more se-
lective stock selection approach should
be used for that sector.
Results
I Aggressive trading parameters are also The results for the four sectors, the
established using the RSH. In this case, Bank sector, the Energy sector, the Medi-
the RSH has to generate a new buy sig- cal sector and the Utility sector are pre-
sented in the following pages. Note that
nal (the RSH has to move back to or
above 7 from a level at or below 4). since the Investor’s Business Dailr data-
Once in buy mode, an aggressive trade base started on ‘i/26/91, three of the sec-
is only activated when the RSH mores tors were already in buy mode at the in-
above 15 and drops bp half. For ex- ception (see tables 1, 3 and 4). Note also
ample, if the RSH rises to a peak of 18.4, that the results are as of s/30/96.
then a sell signal is given when the RSH
drops to or under 9.2. It is only a sell
for aggressive traders. The original
position is not closed out for investors
until the RSH is at or below 4.
An explanation of the parameters is
appropriate before going on to the results.
The parameters were calculated as follows:
1. The RSH was developed by dividing
100% by the 30 sectors. The rationale
behind dividing 100% by 30 is that if
each of the market sectors were to all
post the same number of new highs at
the same time, each sector would make
up 3.33% of the total Market New High
list. This 3.33% gives us a benchmark
number on which to base the RSH, even
though it is understood that it would
be a rare event, even impossible, for all
30 sectors to post the same number of
New Highs simultaneously.
2. The 7 parameter of the RSH was devel-
oped by doubling 3.33% to 6.66% and
rounding up to 7. The 7 is more than
twice the 3.33 benchmark percentage

50 MTA JOURNAL l Winter Spring 1997

 Bank Sector
The Bank sector has given six by sig-
nals and six sell signals. At the inception
of the database, the RSH indicator for the
Banks was in buy territory The sell signal
was activated on 12/21/91. The first by
signal was on 12/26/91 and the first sell
signal on g/14/92. The profit was 7.80%‘.
The results for this sector are summarized
in table 1.
Chart 1 of the Bank index appears with
the accompanying three aforementioned
indicators: the NNH, the RSH, and the
RUZ.
The SNH depicts a few divergences
that were helpful in the early detection of
some corrective pressures for the Banks.
In the three instances indicated on the
NNH chart, the divergences led to correc-
tions and were ultimately confirmed bp sell
signals given bv the RSH. These instances
are pointed out in the chart using the par-
allel lines. The subjective nature of diver-
gence analysis makes it difficult to come
up with consistent conclusions, but used
in conjunction with the RSH it presents a
vital guideline. The NNH can come be-
fore a sell signal, but it is not the sell sig-
nal itself. Note that the divergences onl!
preceded 3 of the 5 sell signals given b!
the RSH.
The RSH chart depicts the indicator
used to generate the buy and sell signals.
By way of review, a move to or above 7
from a level at or below 4 generates a buy
signal, while a move to or below 4 from a
level at or above 7 generates a sell signal.
The chart can also be used to show how
dominant a sector has or hasn’t been. The
Banks, for example, have had five instances
Table 1
since 1991 where the RSH was above
15. This means that the Banks made
up at least 15% of the total number
of New Highs on average over a lo-
day period on five occasions in the
past five years. They have been lead-
ers.
The RMZ can be used to search
for deeper problems in a sector. For
example, if a sector dominates the
New Low list it is perhaps indicative
of more serious structural problems.
A reading above 10 on the RUT is
indicative of a sector that should be
approached more carefullv. The
Banks have not had such a ieading
of 10 on the RMZ since the incep-
tion of this database further accen-
tuating the sector’s strength.
The results of the buy and sell sig-
nals are detailed in table 1. Three
out of six trades (50%) resulted in
profits. The average return on the
Bank Index for all six trades was 12%
versus 6.9% on the S&P 500 for the
same period.
The aggressive trading results
were even more impressive. By way
of review, agqessive trades are acti-
vated when the RSH rises above 15
and drops by half from the peak level.
Four of the five (80%‘) instances had posi-
tive results. h)Iore importantly, however,
each aggressive trading result beat the S&P
500 for the same comparable period. This
is a 100% track record and is true for each
sector analyzed in this paper. The aver-
age profit for the aggressive trades in the
Banks was 14.3% versus 4.1% for the S&P
500.
Bank Sector
MTA JOURWL * I\‘inter - Spring 1997 51
 Energy Sector for the Energ sector, but the S&P
The Energy sector was an interesting 500 did not fare much better.
sector to analyze because it gave more buy/ The better results,asin the Bank
sell signals (9) than any of the other sec- sector,are the aggressivetrading re-
tors reviewed in this paper. sults. The RSH indicator moved
The Energy index and accompanying above 15 twice. Both instances
NNH, RSH and RUZ are found in chart 2. yielded profits that outpacedthe S&P
The NNH provided insight into two of ~00. The averageaggressivetrading
the nine sell signals generated. A look at return for the Energy sectorwas8%
the NSH, however, also shows a noticeable versus.4% for the S&P500.
expansion in the total number of Net New
Highs in 1993 and again in mid 1995 to
the present. The Energy sector has been
among the best performing in 1996.
The RSH provided the buy and sell sig-
nals. Chart 2 shows why there were so
many signals given. Many of the holding
periods were short and not very profitable.
In fact, notice that the Energy trades only
outperformed the S&P 500 in 4 of the 9
(44%) instances.
The RWL moved above 10 on six dif-
ferent occasions since Y/26/91. Notice
that the RUT has not been above 10 since
mid 1995, further accentuating the Energ
sectors strength in 1996.
The results of the buy and sell signals
are detailed in table 2. Fire of the nine
(56%) trades resulted in profits for an av-
erage gain of 2% versus 1.4% for the S&P
500. The total return of the nine buy sig-
nals was .12% versus 1.25% for the S&P
500. The results are not very compelling

Table 2 Energy Sector

I I I /
TRADING RESUI. TS AGGRESSNE TRADING RESULTS
!
I Date Energy Indexi S&P 500 i Buy Sell Energy Return i S&P 500 Return Date Energy Index S&P 500 Energy Raturn:S&P 500 fhturn~

1 Z/l 6/9S 613.56 606.61 x I 1.10% I

l/22/96 625.92 1 613.61 ! ’ x [ / I I
3/l S/96 / 696.36 / 651.69 ( X i / 220% 1 1.70% 3/19/96 696.36 I 651.69 a20% ; -3.40% 1 Indcator Peak
6/2l96 1 711.5 ’ 662.49 ! I x ’ 1
Bo(d
tnding rmdtr md S&P 500 ! ! j ! ~&K$msaiv* UNtiIlg luulta and SW 500 I I
/ I I

52
MTA J&ML l \vinter - Spring1997
 Medical Sector trades was 24% vs. 12% for
The Medical sector, because of its the S&P 500.
growth orientation, has very different The aggressive trading re-
charts than the other sectors analyzed. sults were, once again, im-
The medical sector has given four buy sig- pressive. The RSH was above
nals and fire sell signals (see details in table 15 on four occasions. i!Xen
3). the RSH dropped by half
X review of the NNH (see chart 3) re- from its peak value, a sell sig-
veals no divergence which preceded a sell nal was given. The average
signal. This lack of a divergence, however, gain was 16.5% versus .6R for
is not a reason to disregard the NNH alto- the S&P 500.
gether. Note that the NNH expanded The reason there are onl!
broadly in 1995. At the very least, the SNH two aggressive trades even
can be used as reinforcement of the though the RSH was above 15
strength in the RSH. on four different occasions, is
The RSH chart was used to generate the that only two of the four in- 15 .

buy and sell signals (see chart 3). Note stances above 15 were part of
that four times since 1991, the Medicals a new buv signal. Sotice that
encompassed better than 15% of all New the aggiessive trade was
Highs being posted on average over a lo- closed out on l/10/95, while
day period as opposed to five times for the the longer term trade was
Banks. M%en the Medical sector had its closed out on 6/26/96, about
highest RSH, it took almost hvo years to 1 l/2 years later. In other
generate a sell signal (‘i/8/94 - 6/20/96) words, after the aggressive
and produced a return of 82.3%. trade was closed out, there
The RWL is where the most notable was no sell signal followed b!
chart differences show up. The RWL was a new buy signal.
above 10 on several different occasions. In The Medical sector had
fact, the RMZ went above 10 twice during the highest and most preva-
that hvo year period, where the RSH did lent RWLs above 10 (14
not give a sell signal. Recall that the R\2’L times). The growth charac-
above 10 does not generate a sell signal. teristics of the group make selloffs more
The RWZ is merely used to gauge whether violent. The higher betas and the greater
or not the risk in a sector is increasing. A focus on earnings are reasons for the
reading above 10 is used to consider more deeper selloffs. Banks and Utilities have
careful stock selection in the sector. lower betas and are interest sensitive to
The results in the Medical sector are some extent; Utilities more so than Banks
displayed in table 3. Four of the five trades during this period. Energy stocks are
generated profits for an average gain of greatly influenced by energy commodity
31.3%. The average return of the five prices and to a lesser degree, earnings.

Table 3 Medical Sector

912192 ’ 370.01 417.98 X -4.70% uox I j I

ziai93 I 352.47 431.9 I ' x I n / I I
I
lobw93i 371.67 ' 461.34 x 1- -270% I i
4/2amI 440.24 I x I I I ! I
' 449.1 I n
 Utility Sector
Lastly, I reviewed the Utility sector. The
Utilities had six buv signals and seven sell
signals (see results’ in table 4). None of
the returns proved to be outstanding, but
4 out of the 6 (67%) were positive.
A review of the NNH showed two diver-
gences which led to declines. Indeed, the
second divergence preceded a severe de-
cline of 30%. M’hile divergence analysis is
difficult to quanti@, an analyst can at least
be somewhat alerted to the fact that some-
thing in a sector may be changing, as in
this case the 30% bear market decline in
the Dow Jones Utilitv Index.
The RSH chart shbws something differ-
ent, not seen as clearly in our previous sec-
tor observations. During the deep selloff
in the sector in 1994 and the subsequent
stabilization period, notice that the RSH
started to perk up (see points A, B, and C
in the RSH section of chart 4). The impli-
cation of this is that as the New Low list
was being dominated by Utilities, some
were actually showing up on the New High
list as well. These stocks were the earl!
leaders out of a deeply oversold condition
and indicated that the sector had seen its
worst. Afterwards, the NNH started to
show higher lows and the RUZ dropped
off dramatically. Both indicated that down-
side pressure on the group had eased.
The results of the buy and signals, much
like the Energy Sector, were not very com-
pelling. Five of the seven trades were prof-
itable. The average return of the seven
Table 4 Utility
buy/sell signalsfor the Dow Jones
U&v Index was2% vs. 2.8 for the
S&P 600.
The aggressiveresults, however,
were a bit better. There were three
instanceswhere the RSH wasabove
15. The averageaggressivetrading
gain for the Utilities was3.6% versus
2% for the S&P500.
Conclusion
The four sectorsshownhere are
4 out of 30 suchsectorsin Investor’s
BusinessDaily. These sectorswere
chosen because of their different
characteristics:Banksare character-
ized asvalue/growth, Energies are
considered value/growth, Medicals
are consideredgrowth, and Utilities
are consideredvalue.
The work I have done here is in
its infancy. Divergence analysis,
while subjective,will alwaysbe used
by technical analyststo gain addi-
tional insight. The RSH and the
RMZ, however, attempt to quantify
meaningful changesin a sector.
There are certain weaknesses to
the methodsoutlined in this paper.
First, it is possiblethat different pa-
rameterswork better for different sectors. _ . . 1 1 71
Second, the buy and sell signalsdon’t Lastly the scum were aevelopea DI
alwayscome early. The signalsare usuall! Investor’sBusiness Daily and are somewhat
timely enoughtdgenerate a profit or keep arbitrarv or different than what other ana-
losses to a minimum, but in someinstances lystsmight deemcorrect. The 3.33%used
a lot is left on the table. in my study is not representativeof 3.33%
Sector
MTA JOURN,2L * Winter- opting 1997
of the market and should not be inter- 2IE Sierra Health
lndicies St. Jude Medical
preted as such. The number of issues in STJM
each sector is not equal, the market val- Banks - Price Weighted L’NH United Healthcare
ues are different as well, and the economic IBI Barnett Banks DJUA - Price Weighted
impact of each sector can also change over SK Bank of New York
time. izEP American Electric Power
XB Bank of Boston CNG Consolidated ?Jatural Gas
These weaknesses are obvious, but I feel
SOAT Boatmen’s cx Centerior Energ!
thev are countered by the strengths. First,
:FL CoreStates Financial DTE DTE Energ
ha&g a mechanical trading system using
New Highs and New Lows is useful. The TBS First Bank Systems ED Con Edison
charts are useful because they offer a quick :LT Fleet Financial Group EIX Edison International
reference for spotting changes in a particu- TU First Union Corp. HOU Houston Industries
lar group. The charts offer a way of see- (EY KeyCorp. NAE Noram Energ!
ing the upside leaders, as well as the down- bf;IEL Mellon Bank NhfK Niagara Mohawk
side leaders, more readily than bp just the VB NationsBank Pacific Gas& Electric
PCG
cursory review of the daily New High/ New WC National City Corp. PE Peco Energ
Low list. VOB Norwest Corp.
Another strength is the aggressive trad- PEL PanEnerR
3NE Bank One Corp. PGL PeoplesEnerg!
ing results. The results were positive in 11
PNC PNC Bank UCM Unicorn Corp.
of the 12 (92%) aggressive trades and beat
RNB Republic IV Corp.
the S&P 500 in all 12 (100%). The aver-
age profit for the total combined aggres- 3TI Suntrust Banks
sive trades was 10.9% versus 2.4% for the USBC US Bancorp. Frank Teixeira, CMT
S&P 500. The average profit for the 2’7 \4% LVachovia Corp.
Frank Teixeira recently joined the
trades was 7.‘7% versus 4.9% for the S&P Energy - Price Weighted Technical Department at M’ellington
500. These returns do not include divi- XHC Amerada Hess
dends. The addition of dil-idends would Management Company in Boston.
.APC Anadarko Petroleum Frank wasformerly a Vice President
enhance the returns already mentioned,
BHI Baker Hughes of Merrill Lynch and had been with
particularly in the case of the Utilities.
New Highs and New Lows offer inter- CHI Chevron the lfarket AnalysisDepartmentsince
nal insight into the markets. Charting HAL Halliburton 1991. At Merrill Lynch he published
them bp sector enables us to gain even MRO USX - Marathon
two research reports bi-weekly de-
greater insight. I welcome any suggestions NBR Nabors Industries
signedto give perspectiveson specific
and/or ideas for creating additional pa- NE Noble Drilling
sectorsof the market. He also pro-
rameters for the RSH and the RMZ. I am NFX Nelufield Exploration
currently working on overbought and orer- vided market commentaryand advice
RDC Rowan Companies
sold ideas, as well as some methods for to the retail and institutional sales
RIG Transocean Offshore
mathematically combining the RSH and Schlumberger forces throughout the Merrill Lynch
SLB
the R\Z for generating buy and sell sig- systemon a daily basis. Previously
TX Texaco
nals. Frank spent two yearswith the com-
UCL C‘nocal Corp.
CLR Ultramar Corp. pliance division of The xew York
References Stock Exchange. He received a B.A.
xos Exxon Corp.
1. Martin J. Pring, Technical Analysis Ex- in finance from St.John’s Universi5
plained, McGraw Hill, New York, 1985 Healthcare - Price Weighted
and isan M.B.A. candidateat Hofstra
AMGN Amgen
2. John J. Murphy, Technical Analysis of University.
the Futures Markets, Sew York Insti- BGEN Biogen
tute of Finance, a Prentice-Hall com- BSX Boston Scientific
pany, New York, 1986 CHIR Chiron
COL Columbia HCA
3. Investor’s Business Daily, Los Angeles,
CA, July 26,199l -August 30,1996 GH\ Genesis Health
HCR Health Care and Retirement
HMA Health Management
HRC HealthSouth Corp.
LCA Living Centers of America
LLY Eli Lill!
MDT Medtronic
MME Mid Atlantic Medical
MRK Merck and Co.
OXHP Oxford Health
PFE Pfizer

MTA JOURNAL \\‘inter-Spring 1997

l
55
 Notes

56 MTA JOURNAL l I\‘inter - Spring 1997