October 20, 2014 - Technical Trading
A reader inquired about the validity of Martin Zweig’s Four Percent Model, which states (from pages 93-94 of the 1994 version of Martin Zweig’s Winning on Wall Street):
“The Four Percent Model for the stock market works as follows. First, It uses the Value Line Composite Index…an unweighted price index of approximately seventeen hundred stocks… All you need to construct this model is the weekly close of the Value Line Composite. You can ignore the daily numbers if you wish… This trend-following model gives a buy signal when the weekly Value Line Index rallies 4% or more from any weekly close. It then gives a sell signal when the weekly close of the Value Line Composite drops by 4% or more from any weekly peak. …That’s all there is to it. …The model is designed to force you to stay with the market trend.”
We execute this description as follows (after identifying the first signal):
- After a buy signal, generate the next sell signal upon a 4% or greater decline from a subsequent high water mark (including the buy signal level).
- After a sell signal, generate the next buy signal upon a 4% or greater advance from a subsequent low water mark (including the sell signal level).
We test the usefulness of the signals on the following exchange-traded funds (ETF) over their entire available histories: SPDR S&P 500 (SPY), PowerShares QQQ (QQQ), iShares Russell 2000 Index (IWM) and Guggenheim S&P 500 Equal Weight (RSP). Using weekly closes of the Value Line Geometric Index and the dividend-adjusted weekly opens of the selected ETFs from their respective inceptions through September 2014, we find that: