Technical Trading

A reader requested that we test the stock market forecasts of John Vitale as posted via daily stock market commentary at the Palisades Research web site. The Palisades Research forecasting method involves “a statistical approach to market trading. The technique is unique and proprietary. It relies on two basic elements, ‘money flow’ and ‘investor emotion.’ …The total effort of this program goes into forecasting the direction of the S&P 500 index for the single following day. …Our main program indicates that the next day’s direction can be forecast with a 60% – 70% reliability compared to 53% with buy and hold, but even this is very difficult to maintain in real life.” In this review, we use both regressions and rankings to test the accuracy of the forecasts. Using the record of daily Palisades Research stock market commentary over the period 5/16/06-5/15/08 (499 daily forecasts) and next-day daily opening levels for the S&P 500 index and the Nasdaq 100 index over the same period, we find that… Keep Reading

Is there a predictable market reaction to stocks reaching round-number n-day highs and lows? In their November 2007 paper entitled “Highs and Lows: A Behavioral and Technical Analysis”, Bruce Mizrach and Susan Weerts investigate whether there are systematic trading behaviors for stocks posting 10-day, 25-day, 50-day, 100-day, 150-day, 200-day and 52-week highs and lows. Using daily price data for 488 Nasdaq stocks and 361 NYSE stocks over the period January 1993 through October 2003, they conclude that: Keep Reading

Does technical analysis work after accounting for luck and trading frictions? More specifically, can traders reliably identify technical rules that generate future net outperformance? In the January 2008 version of their paper entitled “Technical Trading Revisited: Persistence Tests, Transaction Costs, and False Discoveries”, Pierre Bajgrowicz and Olivier Scaillet investigate the economic value of technical trading rules applied to long-run daily Dow Jones Industrial Average (DJIA) data. Their approach includes: (1) a new measure of data snooping bias to distinguish between luck and true forecasting power in backtesting; (2) out-of-sample persistence testing of recently successful trading rules; (3) determination of whether certain trading rules work consistently under specific economic conditions; and, (4) incorporation of trading costs. Using daily DJIA price and volume data for January 1897 through July 2007 to test 7,846 rules (filters, moving averages, support and resistance, channel breakouts and on-balance volume averages), they conclude that: Keep Reading

A reader inquired about a test of the BMW Method, defined as follows:

“I trust the CAGR. That is the compound average growth rate. I look back 30 years to get a base number to work from and I then calculate the range of CAGR’s that encompass the full range of stock prices over that 30 year period. The curves are extended into the future by 5 to 10 years and I have a complete picture of what has been and what can be if the business just rolls on along. I buy stocks when they are priced significantly below the lowest historical 30 year CAGR. It happens often. If I cannot find a business that is significantly below the low CAGR, I will settle for some that are on their 30 year lows or just below that level. These do not enthuse me nearly as much, but they will rebound also. The history proves it. This is a definite buy low, sell high concept…except it works. In fact, I want anyone to explain in detail how it cannot work.”

This description is not a precise specification. To test the underlying concept, we hypothesize that the short-term compound growth rate of a broad market index tends to revert to a longer-term compound growth rate. If we enter the market after intervals of relatively low short-term growth and exit after intervals of relatively high short-term growth, we may be able to outperform a buy-and-hold strategy. We use the S&P 500 index to represent the stock market because of its long history. For trading precision we use daily closing levels of the index, with one-year intervals for the short-term growth trend and 30-year and five-year intervals for the long-term growth trend. Using S&P 500 index closing levels for 1/3/50 through 3/3/08, we find that… Keep Reading

Here is a simple test of the usefulness of the Relative Strength Index (RSI) and the Moving Average Convergence/Divergence (MACD), combined, in search of more concentrated abnormal returns. Using those signals and daily dividend-adjusted SPY closing prices from 1/29/93 (the earliest available) through 2/29/08, we find that: Keep Reading

Here is a simple test of the Moving Average Convergence/Divergence (MACD), as calculated using the Exponential Moving Average (EMA) template at StockCharts.com, on a tradable proxy for the S&P 500 index. MACD is the difference between the 26-day EMA price and the 12-day EMA price for an asset. A bullish (bearish) crossover occurs when MACD moves above (below) its 9-day EMA. To reduce the number of very short-term MACD trades, we filter out “close calls” by requiring MACD to reach a level 25% above or below its 9-day EMA before triggering a trade. Using daily dividend-adjusted closing prices for the S&P Depository Receipts Trust (SPY) from 1/29/93 (the earliest available) through 2/29/08, we find that: Keep Reading

A reader asked: “Jason Kelly from the Kelly Newsletter posted this remark in January 2008: ‘A good way to judge trading opportunities on indexes is by watching their MACD and RSI scores. Both together, along with the price chart, give good indications as to whether the odds favor rising or falling from here.’ Is this true?” Here is a simple test of the 14-day Relative Strength Index (RSI), as calculated by the template at StockCharts.com, on a tradable proxy for the S&P 500 index. Note that this indicator measures the strength of price for an asset relative to its own recent past, not relative to other assets. We use the conventional interpretation that values of RSI below 30 (above 70) indicate oversold (overbought) conditions ripe for reversion. Using daily dividend-adjusted closing prices for the S&P Depository Receipts Trust (SPY) from 1/29/93 (the earliest available) through 2/29/08, we find that: Keep Reading

A reader suggested that we evaluate the performance of Between the Hedges, a “portfolio manager’s commentary on investing and trading in the U.S. financial markets.” One prominent and systematic feature of the commentary in that blog is the daily net portfolio position, expressed as percentage long. This position changes frequently, and the portfolio manager presumably manages it to exploit expected short-term trends in the broad stock market. If the expectation has value, the net portfolio position should relate positively to near-term broad market behavior. Using the Between the Hedges daily net portfolio position for 2/2/04-2/26/08 (1,024 trading days) and contemporaneous daily data for the S&P 500 index, we find that: Keep Reading

Several readers have requested that we evaluate the market timing value of Tony Caldaro’s “Objective Elliott Wave (OEW)” analysis. Mr. Caldaro describes OEW as incorporating missing tenets, such that: “Applying these newfound tenets to the market, …the waves were crystal clear. The turning points were precise, to the day, because they were quantitatively derived. There was no question when a wave ended and another began.” Based on the record of “MEDIUM TERM” outlook synopses in Tony Caldaro’s daily commentary blog and contemporaneous daily data for the S&P 500 index over the period January 2006 through January 2008 (523 trading days), we conclude that: Keep Reading

A reader poses the following question: “Have you looked at IntelligentValue? They claim pretty impressive results, apparently certified by FinancialContent. Their Retracement-Value portfolio, particularly, shows impressive results [“508% in its 1st 18.5 months!”]. Are you able to evaluate this newsletter service?” Based on the information provided on IntelligentValue’s web site, especially the closed trade analysis for the [now removed] Retracement-Value portfolio (171 round-trip trades, apparently from portfolio inception on 5/16/06 through 1/9/08, with a starting portfolio value of $10,000), we conclude that: Keep Reading