Periodically I write an article that reviews the past few months of articles. Why on Earth would I do this? Primarily for two reasons. One is that many new readers are involved and often they do not go back and look at the past articles. Two is that my articles are rarely tied to anything that is happening in the markets. Generally, they are about experiences I have had as a technical analyst for 45 years; the good, the bad, and the ugly. You can think of my articles as sections in a book. You can click on the headers for a link to the article.
FOR NEW READERS of THIS BLOG: Below are the links to the past Article Summaries. A suggestion was made by a wise reader that many new readers do not go back and read the old blog articles. I can’t blame them; however, this will provide you with an index and short summary for each of them. Currently, about 152 articles.
In the ninth article in this series I introduce a new indicator I created many years ago that I named the “Combo” indicator. Okay, I didn’t spend a lot of time with the naming of it. A fairly simple concept but turned out to be a really good measure. Basically, it looks at advances and declines but ONLY if the advancing and/or declining volume is above an 18-day moving average. When advancing volume is not above its 18-day average, advances are not used. The same goes for the declines; they are only used when the declining volume is above its 18-day moving average. Finally, I take the ratio of the up volume minus the useable down volume divided by the total volume.
This is the article that I introduce my ranking and selection process. My Weight of the Evidence tells me when to invest and by how much, but one needs to know what to buy. I only buy ETFs and generally these are very liquid and often tied to the broad market or sectors. The ranking measures are there to tell me which ETFs are performing best; in other words, which ones are rising in price. I have 5 mandatory ranking measures which mean an ETF has to meet all 5 requirements before it can be bought. I have many tie-breaker measures which are used in good bull markets when so many ETFs meet the mandatory requirements, I need other measures to help make the decision process.
After a bullish run in the markets, prices slow their ascent because sellers are drying up. This begins the long and often painful process of the market topping; which is also called distribution. Some say the smart holders of stocks are distributing them to the less informed participants. I show the distribution periods of the past two large bear markets and show how it is nearly impossible to know it is a top until the market has moved down significantly; lots of volatility and uncertainty.
This is a process to find strength in ETFs during an up move that follows a pullback in the market. The thinking is that those issues which dropped the least in the pullback will probably outperform in the following rally. You measure the percentage of the pullback moves and rank the ETFs according to their category; broad, style, sector, international, and misc. Then you measure their performance from the beginning of the rally to the current date. Next you look at the ratio of rally performance percentage to pullback percentage. And finally you look at the ETFs performance from the high that defined the beginning of the pullback.
Here I expand on the concept of ranking and selection measures that I initiated in article 10 in this series. Further information is shared on mandatory measures and I show exactly what they are. I also show some of the tie-breaker measures and explain how best they are used. In this article I actually show you a section of my ranking and selection worksheet which also includes some statistical data on the top ETFs.
Modern finance believes the market price action is random and normally distributed. That is just plain hogwash. Markets trend because of buying enthusiasm; investors see the markets rise and know they will have to pay a higher price to participate; likewise, sellers know they can ask for a higher price. Eventually the sellers dry up and the trend ends. I talk about the nonsense of ‘cash on the sidelines’ and how the media is so wrong when they say there are more sellers today when the markets decline. You’ll want to read this article.
During periods of market volatility when it seems no strategy is working well, many will challenge one’s process. You must have discipline to stick with your strategy during the inevitable periods when results are less than perfect. There are two emotions that can override intelligence and consume investors and their money, testing their discipline to stick with the process, and those are fear and greed. I tell a couple of real life stories on how some lose their ability to stick with their process.
This is where I finally introduce the details on my Weight of the Evidence process showing how each of the measures are weighted and combined into the various categories. I list the indicators and show charts of each along with their digital signals. And finally, I show the full chart of how the weight of the evidence moves from zone to zone; with each zone having its own set of buy rules, stop loss levels, etc. I have used this model for decades with only very slight modifications along the way. Tweaking a model is how many begin to completely fall apart in their discipline.
As I near the end of this series on ‘Building a Rules-Based Trend Following Model’ in this article I show how to develop buy rules, sell rules, and guidelines. I treat the rules as inviolable. Bottom line here is that you CANNOT break a rule. Period! The guidelines on the other hand are there to help guide your decision-making process. They are not mandatory but exist to keep you focused on the goal of following your model. An example of a buy rule is that I do not trade in the first 45 minutes of the trading day simply because there is too much volatility and indecision. Also I do not trade in the last hour of the trading day as I always want adequate time for a good execution when buying or selling.
Over the years, I always seem to write about all the noise generated by the financial media and Wall Street. Noise is the short-term interference that causes investors and traders to deviate from a well thought out investment plan. The emotional roller coaster of trying to utilize all this information can have a devastating affect on your wealth. This noise is difficult to ignore because at the time it seems so important. Again, a sound reason to follow a rules-based process.
Tushar Chande wrote an article comparing my Weight of the Evidence with his new Chande Trend Meter. I was delighted as this will give me an opportunity to continue developing my ideas on model building by using his CTM. I show a chart comparing his CTM with my WoEv during the last bear market from 2007-2009. They, at first glance, are very similar but upon closer examination there are some significant differences. Mainly that my WoEv uses price AND breadth, whereas his CTM is only price-based. I have written a number of articles in the past on the value breadth offers to a trend following model.
My article naming process is certainly not glamourous. When I continue to expound on a subject I just use the same title following with its numerical order. Here I show Tushar Chande’s CTM and also show how by using a 5-period exponential average of it can greatly reduce its volatility. I attempt to explain the differences which are almost always because my WoEv uses market breadth and his CTM does not. I show a chart comparing CTM along with the 5-period smoothed CTM. I also show a chart of my WoEv and 5-period smoothed CTM on the bear market at the beginning of this century.
Dance with the Trend,