Market Technician No 46

Last Octobers IFTA conference was heralded as a great success.
For those
of you who were not able to attend, transcripts of some of the
presentations are included in this issue. Next year the IFTA conference will
be hosted by the MTA and will take place in Washington. More details will
be given later.
We would like to take this opportunity of thanking David Charters and Elli
Gifford for donating a number of their books on technical analysis to the
library. The Societys postal library service provides an invaluable service
to members all over the country and donations of books are always
welcome but they do need to be in good condition.
A number of changes have been made to the Societys website
(www.sta-uk.org) in order to allow us to offer new services and
information to members. The website is viewed by the STA board as a
very useful means of fulfilling our mission, namely to promote greater use
and understanding of technical analysis as a vital investment tool.
The changes that we have implemented over the last year and a half were
basically to make sure that we put up relevant information on the website
as soon as possible and to make sure that what was on the website was
informative, useful and easy to find. One note of success was that we
actually used the website to accept bookings and payments for the IFTA
conference last year, as well as having all of the documentation for the
conference up on the web well ahead of the snail mail deliveries.
The home page is our face to the world and we try to make sure that any
relevant changes to the site, meetings, education courses and events are
flagged here in the first instance. By visiting our home page members
and non-members see the STAs mission statement, logo, links to articles
describing what technical analysis is all about and the latest information
about events, courses and meetings in bullet points. Access to the main
programmes of the STA is provided by having a permanent index on our
home page directing the user to our Education, Meetings, Reference
Source, Journal, Membership, Committee, Useful Links, Recruitment and
Charts sections.
In the public area of the website we will be introducing a Frequently
Asked Questions (FAQ) section, where payment information, course
information, location and timing of courses will be made even clearer.
While all of this information is on the web in one form or another, there
are a number of routine questions that could probably be listed in the
FAQ section to make life simpler for students and prospective students.
We are always trying to put information onto the web regarding speakers,
special events, changes to any schedules etc. as soon as it is available but,
judging from the emails that are received on this, the more forward
looking that we can be, the better!
The main changes over the coming year should be in the long awaited
members only section. The purpose of our members only section is to
promote greater use of our archived material, allow members to post their
details for contact on certain markets or issues if they so desire and to
provide some of the monthly meeting speaker notes and slides after the
meetings. For students enrolling on a STA course there will be more
information on the coursework together with notes and some practice
exams. We also plan on putting some store fronts in this section such as
links to online booksellers etc. We will be working with some of the
recruitment firms to post positions in the members only section when
appropriate and will be putting up a notice board for members interested
in new employment opportunities. These are just the first steps in this
section and as members use it and come up with their own ideas the
website will continue to evolve. If you have any ideas or suggestions
please contact Gerry Celaya who chairs the website committee.
IN THIS ISSUE
G. Celaya IFTA walk about . . . . . . . . . . . . . . . . . . 2
Obituaries . . . . . . . . . . . . . . . . . . . . . . . 3
I. Stannard & Optimising entry levels for
P. Wilkinson maximum risk control . . . . . . . . . . . . 4
H. Okamoto Asset allocation in Japanese and
US stock markets by means of
technical analysis . . . . . . . . . . . . . . . . . 7
N. Elliott Option strategies using Ichimoku
Kinko clouds . . . . . . . . . . . . . . . . . . . . 11
P. Beuttell Still a Great Bear Market . . . . . . . . . 15
R. Acampora &
E. Keon The pattern of war . . . . . . . . . . . . . . 16
March 2003 The Journal of the STA
Issue No. 46 www.sta-uk.org
MARKET TECHNICIAN
COPY DEADLINE FOR THE NEXT ISSUE
31st May 2003
PUBLICATION OF THE NEXT ISSUE
July 2003
FOR YOUR DIARY
4th April Revision Course
9th April Joint Meeting with the
Society of Business Economists
25th April STA Diploma examination
14th May Monthly meeting
11th June Monthly meeting
9th July Summer party
N.B. The monthly meetings will take place at the
Institute of Marine Engineers,
80 Coleman Street, London EC2 at 6.00 p.m.
MARKET TECHNICIAN Issue 46 March 2003 2
I had the pleasure of helping with the famous Walk About session at the
IFTA conference in October and hosting one of the Software discussion
tables. This session helps the delegates to get to know each other as they
discuss various topics in an informal setting. Ian Notleys experience in
running these sessions ensures that all delegates meet exactly half of the
total number of delegates. It is interesting to discuss different techniques
and tools and, in the case of the table that I was chairing, software, with
delegates from every corner of the world.
Almost all of the delegates used technical analysis as a professional
investment tool and most also used the techniques in their private
investment decisions as well. (I was surprised that all of the delegates did
not use technical analysis in their personal investments.) The software or
trading station that was most frequently cited was Bloomberg, followed
by Reuters, Metastock, Tradestation, CQG, Updata, Insight Trader and
TC2000.
The choice of software could, in most cases, have a lot to do with the
nature of the delegates job. It seems that many of the delegates that
came through my table were employed as equity analysts, portfolio
managers (equity) or equity traders. The software package on their desks
seemed to be Bloomberg or Reuters, as the combination of some
graphics/technical tools and a robust data feed was difficult to match. For
chart scanning/screening and systems testing it seemed that Metastock
and Tradestation were still widely used. The futures market delegates
cited CQG as their main tool, while the UK delegates mentioned Updata as
a stock charting software of choice. Australians and US delegates were
keen on TC2000 as a stock-screening tool (end of day in almost all cases).
Some Reuters Graphics users felt that Reuters could do better but I hope
that these delegates managed to take a look at the state-of-the-art
Reuters software that was on display in the exhibitors hall. Coming from
an FX world, it was strange not to hear TraderMade mentioned but there
seemed to be very few FX delegates on my side of the room.
Data feeds were a concern as the high price of live data was mentioned at
every group meeting. On the positive side, there were very few
complaints of bad data or spikes not being corrected. This is a huge
improvement, and the Data Committee may want to take a bow after
many years of lobbying the industry to clean up their act. Datastream
was one of the favourite data feeds for the equity market participants,
with e-signal, CSI and the TC2000 feed cited as well. Probably one of the
most frequently mentioned pieces of software was Microsofts Excel, as at
one time or another almost every table had a discussion about how to
import/export data and different uses for this software work horse.
Websites that the delegates used every day seemed to rotate around
news, quotes and charts. Lycos.com, yahoo.com finance, the FT, Wall St.
Journal etc. all made it to the top of the list. Bigcharts.com and
stockcharts.com were the favourites for stock market traders for charting
shares. Very few delegates mentioned chat rooms or bulletin boards.
Whether this was because they had found the holy grail and did not want
to share it or because they simply did not use them was unclear but the
few who did mention them usually said that they were a waste of time
unless you signed up to the advanced levels. Systems developers seemed
to prefer to use a combination of bespoke software, Excel and
Tradestation/Metastock and math software in their work. The keys for
many of these practitioners were the ability to back test their strategies,
and to look for risk analysis, stress testing and quantify their risk/reward
profile.
For the future, the delegates on my side of the room seemed pretty
optimistic. Lower data and internet access prices were anticipated and it
seems that we have become used to computers becoming easier to use,
faster and cheaper every few years or so. It was interesting to hear that
not one single piece of software seemed to be the catch all for most users
but that a few pieces of software and data were still deemed necessary to
get the job done. Maybe the knock out software that has all of the data
handling capabilities, portfolio functions, systems and modelling
capabilities plus the technical tools, macro writing, great charting plus a
comprehensive data feed, all for very little money, is just around the
corner?
Gerry Celaya
CHAIRMAN
Adam Sorab,
Deutsche Asset Management,
1 Appold Street, London EC2A 2UU
TREASURER
Simon Warren. Tel: 020-7656 2212
PROGRAMME ORGANISATION
Mark Tennyson d'Eyncourt.
Tel: 020-8995 5998 (eves)
LIBRARY AND LIAISON
Michael Feeny. Tel: 020-7786 1322
The Barbican library contains our collection. Michael buys new books for it
where appropriate. Any suggestions for new books should be made to him.
EDUCATION
John Cameron. Tel: 01981-510210
George Maclean. Tel: 020-7312 7000
EXTERNAL RELATIONS
Axel Rudolph. Tel: 020-7842 9494
IFTA
Anne Whitby. Tel: 020-7636 6533
MARKETING
Kevan Conlon. Tel: 020-7329 6333
Barry Tarr. Tel: 020-7522 3626
MEMBERSHIP
REGIONAL CHAPTERS
Robert Newgrosh. Tel: 0161- 428 1069
Murray Gunn. Tel: 0131-245 7885
SECRETARY
Mark Tennyson dEyncourt.
Tel: 020-8995 5998 (eves)
STA JOURNAL
Editor, Deborah Owen,
108 Barnsbury Road, London N1 OES
Tel: 020-7278 4605
Please keep the articles coming in the success of the Journal depends
on its authors, and we would like to thank all those who have supported
us with their high standard of work. The aim is to make the Journal a
valuable showcase for members research as well as to inform and
entertain readers.
The Society is not responsible for any material published in The Market
Technician and publication of any material or expression of opinions
does not necessarily imply that the Society agrees with them. The
Society is not authorised to conduct investment business and does not
provide investment advice or recommendations.
Articles are published without responsibility on the part of the Society,
the editor or authors for loss occasioned by any person acting or
refraining from action as a result of any view expressed therein.
Networking
WHO TO CONTACT ON YOUR COMMITTEE
IFTA walk about
Issue 46 March 2003 MARKET TECHNICIAN 3
BRONWEN WOOD 1942-2002
Bronwen was born in Australia, but her father was English and the family
came to England when she was a young girl. After studying at Bristol
University she was first a teacher, then acted as a House Mother at a
school in America, but decided on returning to the UK that she wanted to
pursue a career in the City. She joined what was then Hedderwick
Borthwick, moving to Chart Analysis in 1971. From there she went to
Rowe and Pitman, which eventually became part of Warburgs, then
Quilter Hilton Goodison, which itself became part of CU. In 1993 she
accepted a job at ADIA in Abu Dhabi, where she stayed until returning to
live in England in 1999.
In 1986, when the previous Association of Chart and Technical Analysts
(ACTA) was incorporated and renamed the STA, the then Chairman, Philip
Gray, and Bronwen decided that we needed to develop a formal
qualification in the technical analysis field. So began the STA Diploma,
and the courses leading to the examination. In the early years Bronwen
wrote and marked all the papers. Those first students would not have
recognised todays type of course; in the beginning it took the form of a
solid week of evening lectures, and that was it. However, even when she
went to work in Abu Dhabi from 1993 to 1999, Bronwen retained a lively
interest in how the educational side of the STA was progressing, and was
very impressed with the course as it now operates.
There are also many individual members who had their interest in
technical analysis fired or increased by talking to her and listening to her
views on the markets. Many of them have said Bronwen taught me
about technical analysis, not just at formal courses, but through
conversations with her.
In addition to her work for education in the Society, Bronwen was a great
technical analyst, rated one of the best by her peers, particularly for her
work on the equity indices and individual shares. For both her
contribution to education, and for her outstanding analytical skills, she
was awarded the Fellowship of the Society in 1993.
Bronwen was also a long-standing member of the Board of IFTA and of its
Executive Committee, most recently as Secretary as well as Chairman of
the Nominations Committee. Through this connection, she was widely
respected throughout the world, as well as in the UK, as an outstanding
technical analyst and an expert in the teaching of technical analysis.
However, those who knew Bronwen will not remember her just for her
teaching skills, the enthusiasm and integrity of her approach to technical
analysis and her consummate professionalism. They will remember her
lively and forthright conversation, her humour, her radiant smile and
perhaps most of all her wonderful infectious laugh. All these things can
never be forgotten, and never replaced.
Bronwen died on 30 December 2002, aged only 60. In her memory, the
Board of the STA has voted to create an annual award for the best
Diploma paper. This will be known as the Bronwen Wood Memorial Prize.
HARVEY STEWART 1934-2002
Harvey was born in Dublin in 1934, moving across the Irish Sea with his
parents soon afterwards and was educated at Westminster School. From
there he won a scholarship to Trinity College, Cambridge. His first and - as
it turned out only job was at Investment Research in Cambridge where
he quite soon became the first ever business partner of the doyen of
European technical analysis, Alec Ellinger. They were later joined by John
Cuningham, David Damant, Elli Gifford and David Charters.
Harvey was one of the founders of The Association of Chart and Technical
Analysts (ACTA) which became todays Society of Technical Analysts. He
served at various times as the Treasurer and Membership Secretary and
was always an enthusiastic attendee of the monthly meetings. His work
for the society was recognised when he was awarded a Fellowship.
Eventually his partners at Investment Research all became Fellows of the
Society a unique achievement.
After he had updated Alec Ellingers A Post-War History of the
Stockmarket, Harvey soon became an author in his own right when
How Charts Can Make You Money was published by Woodhead-Faulkner
in the 1980s. It became one of their best-selling titles.
The successful Cambridge conferences on technical analysis, which ran
from the late 1960s for exactly 30 years, brought Harvey into contact with
many fellow technicians. Many will remember his extraordinary kindness,
his drinking capacity and that voice rich, mellow and precise.
After retirement in 1984, Harvey moved to France, restoring a house in
Autun, Burgundy, but he continued to return every year for the Cambridge
conference; for many years he wrote the official rsum. Eventually he
returned to live in the centre of Cambridge. His slightly premature death
in October 2002 from leukaemia, aged 68, is a great loss to us all. Harvey
was a true Edwardian gentleman, born out of his time.
ANY QUERIES
For any queries about joining the Society, attending one of the
STA courses on technical analysis or taking the diploma examination,
please contact:
STA Administration Services (Katie Abberton)
Dean House, Vernham Dean, Hampshire SP11 0LA
Tel: 07000 710207 Fax: 07000 710208
www.sta-uk.org
For information about advertising in the journal, please contact
Deborah Owen
108 Barnsbury Road, London N1 OES. Tel: 020-7278 4605
Scottish Conference
The Scottish Chapter of the STA is pleased to announce
that it will be holding the 3
rd
Annual Conference on March
21
st
, 2003 at the Caledonian Hotel in Edinburgh.
The guest speakers are Martin Scott (RBS), Julian McCree
(Manro Haydan), Julius de Kempenaer (Kempen and Co.)
and Raynard Cheng (CSFB). Murray Gunn (Standard Life
Investments) and Gerry Celaya (Redtower Research) will
represent the Scottish chapter as local speakers and we
hope to have Adam Sorab (Chairman of the STA) as the
keynote speaker at lunch. The previous conferences
proved very popular and we were literally at standing
room only levels at the 2
nd
Conference so early booking is
advised.
We would like to thank RBS Financial Markets, Reuters,
TraderMade and Redtower Research for their sponsorship
of this event and we look forward to seeing you there.
The conference fee is 60 for STA members/associates and
IFTA affiliates which covers the full day including lunch and
coffee breaks.
Please contact Katie Abberton at the STA Administrative
Services (tel. 07000 710 207) or email at info@sta-uk.org.
Details are also at www.sta-uk.org/sta_in_scotland.htm.
Obituaries
A question often asked by traders after a breakout is, do I buy/sell the
breakout or wait for a pullback? The problem for the analyst is to decide if
a pullback will occur, or will the move accelerate away, leaving the trader
stranded without a position. Technical analysis theory suggests that a
breakout from a major consolidation range, reversal pattern, or even just a
break of a major trend line (support/resistance) will result in an initial
sharp move in the direction of the breakout followed by a corrective
pullback to retest the breakout point. But, as we are all aware, markets do
not always behave exactly as textbooks describe. Indeed, false breakouts
resulting in reversals and runaway markets can make trading breakouts
extremely hazardous.
Hence, here we examine the behaviour of markets after a sharp move
(which may or may not be associated with a breakout from a specific chart
pattern) in an attempt to determine whether an optimal entry level can be
easily identified. For this exercise we have studied the case of US dollar
against the Japanese yen (USD/JPY) given its tendency for sharp moves and
volatile trading behaviour. Indeed, USD/JPY has a reputation for generating
large moves, with moves of over one-percent per day not uncommon. In
fact, in our test, we specifically examine moves of over one-percent within a
day and analyse the trading activity in the following four days.
Specifically, we estimate the probability of USD/JPY continuing to attain
extreme levels in the four days following a 1% or more move for a given
corrective pullback, ranging from a 10% pullback to a 100%-plus
correction of the initial move. The sample data used for this estimation
was daily high/low/close data from January 1988 to January 2002, testing
the possibility of returning to an extreme level within four days
conditional upon exhibiting an initial 1% or more jump followed by a
corrective pullback (see chart 1).
Chart 1
For a positive market jump of 1% or more in High[today]-Close[today-
1]/Close[today-1], and then a pullback where (Close[today]-Close[today-
1])/Close[today-1] is within a given range how many times have we
returned to the level High[today], within the following four business days?
Correspondingly, we also estimate the probability of attaining the low
level again after a large negative market jump of -1% or more.
In the sample data there were 470 cases meeting our criterion of a 1% or
more move to the upside. Of these 470 cases, 332 developed a corrective
pullback (we defined corrective pullback as a counter move retracing at
least 10% of the initial jump or spike). On the downside, there were 508
cases meeting our criterion of at least a 1% move, with 420 developing a
pullback. This initial finding is very noteworthy in itself, as it shows that in
the majority of cases, after a significant move in price action, there is in
fact at least a correction of the initial move. This would tend to support
technical analysis theory of a correction after a breakout, and to imply
that waiting to enter a position, rather than immediately entering the
market after a breakout, would be the preferred strategy. But the next
step of the test is crucial as here we attempt to determine if there is an
optimal entry level, using the correction to establish a position in
anticipation of a continuation of the trend in the direction of the initial
breakout.
Fibonnacci analysis is often used to estimate the extent of a potential
corrective pullback (especially for the application of Elliott Wave Analysis),
with the 38.2% and 50% retracement levels seen as targets for a
correction, which is likely to produce a continuation of the trend. It is
perceived that retracements beyond the 61.8% level are likely to result in
a full retracement of the previous move. With this theory in mind, we
estimated the probabilities of USD/JPY returning to extreme levels for a
given percentage corrective pullback.
Indeed, we carried out a series of tests to determine the probability of
USD/JPY achieving a new extreme level within the next four trading days
for a given size of corrective pullback after the initial 1%+ move. The
corrective pullback was measured as the percentage counter trend move
from the intra-day extreme to the close. Tests were carried out on
corrective pullbacks in 10% point steps from the intra-day extreme,
starting with a 10% pullback, right through to a 100%+ retracement of the
original move.
In fact, three tests were carried out, the first examining the probability of
USD/JPY returning to the extreme level within four days after the initial
1%+ move for cases pulling back more than the specified retracement
level (Table 1). For example, study the case of Pblim = 0.9 (10%
pullback). In 363 of the 470 cases the Close of that day, i.e. Close[today],
is up by at most 0.9*X percent. Now, in 246 of these 363 cases, 68%, we
returned to at least the level of High[today] within the following four
business days.
The second test examined the probability of USD/JPY returning to the
extreme level within four days of the initial 1%+ move for cases pulling
back NOT more than the specified retracement level - a pullback leading
to a Close[today] up at least (PBlim*X)% (and at most X%, that is
Close=High), (Table 2). For example, study the case of Pblim = 0.9. For the
whole sample we have 470 jumps of at least 1%. In 107 of these cases the
Close of that day, i.e. Close[today], is up between (0.9*X)% and X%. Now,
in 105 of these 107 cases, 98%, we returned to at least the level of
High[today] within the following four business days.
The third test examined the probability of the extreme ( High[today] or
Low[today] ) being achieved after a corrective pullback into a given range
(see Table 3).
Detailed analysis of the results in Tables 1-3, reveals some interesting
information about market behaviour, which appears to support technical
analysis theory and general market perceptions. Indeed, these results are
consistent with the theory that following a breakout (here simulated by
a 1%+ move) a corrective pullback should be expected and that a
shallow correction will result in a continuation of the developing trend in
the direction of the breakout. Indeed, we found that in around 77% of
cases following a 1%+ rise, a pullback was witnessed, and that in 82% of
cases following a 1%+ decline a pullback was recorded. Of these
pullbacks we found that 74% in the case of an up move and 71% in the
case of a down move, registered a retracement of between 10% and 50%.
Given that the vast majority of pullbacks after a sharp move higher fall
into the 10% to 50% retracement zone, a closer study of the observations
falling into this category is justified, and indeed throws up some
interesting results. The results of our tests suggest that the probability of
USD/JPY going on to extend the trend following a pullback of over 0.6
(40% retracement) is greatly reduced and is in fact not that significantly
different from 50%. This is obviously consistent with the Fibonnacci
retracement level of 38.2%.
Optimising entry levels for maximum risk
control
By Ian Stannard and Dr Petra Wikstrom
Close[today-1]
High[today]
Close[today]
(<High[today] )
X > 1%
Within following
4 business days
Also of interest is the distribution of the successful cases (Chart 2 -
distribution of successful cases in an upmove), which shows that the 0.8
level (20% retracement) represents 50% of successful cases. The
distribution chart falls away sharply to the 0.5 level (50% retracement),
where there are only a very limited number of successful cases. This
provides further evidence to support the market perception that a limited
pullback (20% retracement) after a sharp move will result in a
continuation of the trend, while a deeper pullback (over 50% retracement)
greatly reduces the chance that the trend will be resumed.
Chart 2
Distribution of successful cases following a 1% or more upmove. Pullback
versus density (numbers of cases). The area beneath the curve is 1.
For PBlim around 0.80 divides the area in to two equal parts. That is
around 50% of successful cases have had a Close[today] between 0.8 and
1. The corresponding distribution chart of successful cases following a
1%+ down move is very similar.
-1.0 -0.5 0.0 0.5 1.0
0
.
0
0
.
5
1
.
0
1
.
5
2
.
0
2
.
5
3
.
0
PBli m
d
e
n
s
i
t
y
Table 1:
In the case of a pullback more than the specified retracement level. Close[today] at most Pblim*X. Number of cases returned within four days: Rethi, Retlow.
hi hilow hilowhi low lowhi lowhilow PBlim Rethi Retlow hiPB lowPB
470 32 10 508 34 11 0 31% 32% 7% 7%
470 37 14 508 41 15 0.1 38% 37% 8% 8%
470 47 20 508 60 23 0.2 43% 38% 10% 12%
470 58 24 508 74 29 0.3 41% 39% 12% 15%
470 70 29 508 93 39 0.4 41% 42% 15% 18%
470 96 44 508 121 59 0.5 46% 49% 20% 24%
470 123 60 508 161 87 0.6 49% 54% 26% 32%
470 177 96 508 225 128 0.7 54% 57% 38% 44%
470 247 148 508 306 190 0.8 60% 62% 53% 60%
470 363 246 508 420 288 0.9 68% 69% 77% 83%
Table 2:
In the case of a pullback NOT more than the specified retracement levels. Close[today] between (PBlim*X)% and X%. Returned within four days: Rethi, Retlow.
470 439 341 508 475 361 0 78% 76% 93% 94%
470 433 337 508 467 357 0.1 78% 76% 92% 92%
470 423 331 508 448 349 0.2 78% 78% 90% 88%
470 412 327 508 434 343 0.3 79% 79% 88% 85%
470 400 322 508 415 333 0.4 81% 80% 85% 82%
470 374 307 508 387 313 0.5 82% 81% 80% 76%
470 347 291 508 347 285 0.6 84% 82% 74% 68%
470 293 255 508 283 244 0.7 87% 86% 62% 56%
470 223 203 508 202 182 0.8 91% 90% 47% 40%
470 107 105 508 88 84 0.9 98% 95% 23% 17%
Table 3:
In the case of a pullback within a specified region of between 0.9-0.7, 0.8-0.6, 0.7-0.5 and so on...
470 21 10 508 33 14 0.3 48% 42% 4% 6%
470 23 9 508 33 16 0.4 39% 48% 5% 6%
470 38 20 508 47 30 0.5 53% 64% 8% 9%
470 53 31 508 68 48 0.6 58% 71% 11% 13%
470 81 52 508 104 69 0.7 64% 66% 17% 20%
470 124 88 508 145 103 0.8 71% 71% 26% 29%
470 186 150 508 195 160 0.9 81% 82% 40% 38%
Table Key:
hi = Number of cases which moved higher 1% or more in one day.
hilow = Number of cases that after moving higher 1% or more then pullback into a specified region.
hilowhi = Number of cases that after a pullback into a specific region go on to achieve or exceed the previous high within the following 4 business
days (number of successful cases).
low = Number of cases which moved lower 1% or more in one day.
lowhi = Number of cases that after moving lower 1% or more then pullback into a specified region.
lowhilow = Number of cases that after a pullback into a specific region go on to achieve or exceed the previous low within the following 4 business days
(number of successful cases).
PBlim = The specified pullback region (0.9 = 10% retracement, 0.8 = 20% retracement etc.).
Rethi = Probability of a pullback within a specified region achieving or exceeding the previous high within four business days.
Retlow = Probability of a pullback within a specified region achieving or exceeding the previous low within four business days.
hiPB = Percentage of cases that moved 1% higher or more in one day that achieve a specified pullback region.
lowPB = Percentage of cases that moved 1% lower or more in one day that achieve a specified pullback region.
Conclusion
The results of the above tests suggest that following a sharp move in price
(in this case a 1%+ move in USD/JPY), it is highly likely that a corrective
pullback will follow. Although in most cases a new extreme level is
reached after the pullback, the probability of the trend being resumed is
significantly affected by the extent of the corrective pullback. Indeed, we
have found that close analysis of the extent of the pullback significantly
increases the probability of participating in a profitable trade by
identifying potentially more advantageous entry levels for investors to
participate in a further extension of the breakout move.
We have found that the 0.6% pullback (40% retracement level) is
extremely important. Indeed, there is a very high probability that
pullbacks that do not extend beyond this level will go on to extend the
trend in the direction of the breakout. However, pullbacks that extend
beyond the 40% retracement level have a much reduced probability of
extending the move. In fact, our tests show at this stage, the chances of
participating in a profitable trade are not significantly different from 50%.
Given that the vest majority of pullbacks after a sharp move do in fact
remain limited (our tests found that 50% of pullbacks only retrace 20%), a
well constructed trading strategy aimed at pullbacks of less than 40%
should still provide a high level of participation. In the case of USDJPY, our
tests suggest that using the 40% retracement level as a cut off point, an
investor would have only missed out on 17% of the potentially profitable
trading opportunities (although these 17% are potentially highly
profitable given the favourable entry level that would have been
achieved) while avoiding 53% of the likely unprofitable situations.
APPENDIX
Test Details
The probability estimates of returning to the extreme level, conditional
upon having exhibited a jump and a pullback in a certain range, are
obtained by simply counting the number of times this has happened. We
use chi-square statistics to test whether the conditional probabilities are
statistically different from 50%. For a 95% level or better, the p-value is at
maximum 5%, which therefore corresponds to a chi-squared value of at
least 3.84. Also a 90% confidence interval for all probabilities is given,
where the upper and lower bound values each can be rejected on the
95% level.
Test Statistics
Test Statistics key
ChiHi = Chi square for successful cases following a 1% or more
move higher for a specific pullback region.
pvalHi = P-value for successful cases following a 1% or more move
higher for a specific pullback region.
ChiLow = Chi square for successful cases following a 1% or more
move lower for a specific pullback region.
pvalLow = P-value for successful cases following a 1% or more move
lower for a specific pullback region.
CintUPhi,
CintDownhi = 90% confidence interval for successful cases following a
1% or more move higher for a specific pullback region.
CintUPlow,
CintDownlow= 90% confidence interval for successful cases following a
1% or more move lower for a specific pullback region.
Ian Stannard is Senior Currency Strategist, and
Dr Petra Wikstrom is Quantitative Analyst at BNP Paribas
Test 1:
In the case of a pullback more than the specified retracement level
ChiHi pvalHi ChiLow pvaLow CintUPhi CintDownhi CintUPlow CintDOWNlow
4.50 0.034 4.24 0.040 49% 18% 49% 19%
2.19 0.139 2.95 0.086 54% 24% 52% 24%
1.04 0.307 3.27 0.071 57% 30% 51% 27%
1.72 0.189 3.46 0.063 54% 30% 51% 29%
2.06 0.151 2.42 0.120 53% 31% 52% 32%
0.67 0.414 0.07 0.785 56% 36% 58% 40%
0.07 0.787 1.05 0.306 58% 40% 62% 46%
1.27 0.260 4.27 0.039 61% 47% 63% 50%
9.72 0.002 17.9 0.000 66% 54% 67% 57%
45.8 0.000 57.9 0.000 72% 63% 73% 64%
Test 2:
In the case of a pullback NOT more than the specified retracement levels
134.5 0.000 128.4 0.000 81% 74% 80% 72%
134.1 0.000 130.6 0.000 81% 74% 80% 72%
135.0 0.000 139.5 0.000 82% 74% 82% 74%
142.1 0.000 146.3 0.000 83% 75% 83% 75%
148.8 0.000 151.8 0.000 84% 76% 84% 76%
154.0 0.000 147.6 0.000 86% 78% 84% 77%
159.1 0.000 143.3 0.000 87% 80% 86% 78%
160.7 0.000 148.5 0.000 90% 83% 90% 82%
150.2 0.000 129.9 0.000 94% 87% 93% 85%
99.1 0.000 72.7 0.000 99% 93% 98% 89%
Test 3:
In the case of a pullback within a specified region
0.05 0.827 0.76 0.384 68% 28% 59% 27%
1.09 0.297 0.03 0.862 59% 22% 65% 33%
0.11 0.746 3.60 0.058 68% 37% 76% 50%
1.53 0.216 11.5 0.001 71% 45% 80% 59%
6.53 0.011 11.1 0.001 74% 53% 75% 57%
21.8 0.000 25.7 0.000 78% 62% 78% 63%
69.9 0.000 80.1 0.000 86% 74% 87% 76%
STA DIPLOMA EXAMINATION
The diploma examination will be held on Friday
25th April 2003 at London School of Economics,
Houghton Street, London WC2A 2AE. Registration
is at 12.45pm and the exam lasts for three hours.
The entry fee is 350.00.
If you wish to sit this exam, please contact:
STA Administrative Services
Dean House,
Vernham Dean,
Hampshire SP11 0LA
Tel: 07000 710207 Fax: 07000 710208
www.sta-uk.org
REVISION DAY
An essential for serious candidates
2001 diploma candidate.
Prior to the exam, there will be a one day revision
course on Friday 4th April 2003. The cost (including
lunch) is 250.00. Those wishing to attend should
contact STA Administrative Services.
Characteristics of fluctuations in the Japanese and US
stock markets.
Looking at daily stock price changes, the Japanese stock markets are
significantly affected by the fluctuations in the US markets. The US market
opens half a day later than the Japanese market. But when placed in the
order of influences, the US market gives influences to the Japanese
market one half a day later, as can be seen in Figure 1. The U 1, namely,
up 1 in Figure 1 shows the first rise in the US market while the IU 1,
namely, influenced up 1 shows a rise in the Japanese market, influenced
by the US one. The influences of the U 6 appear in a form of the IU 6
half a day later. However, daily minute changes as above are different
from a long-term trend. As far as a trend is concerned, the Japanese
market does not always follow the US one. This means that in some cases
the Japanese market is bullish while the US one is bearish, and in other
cases it is bearish while the US one is bullish. Past history provides
evidence of this. Figure 2 indicates the mechanism in which both markets
do not show coincident trends while they are closely interlocked in a
short time span. As you see in Figure 2, daily U 1 and IU 1, and U 7 and
IU 7 coincide with each other, but a lack of correlation is seen when
viewed from a trend level (namely, trends are in opposite directions).
During the period from the end of the Second World War up to now, stock
price trends in the two markets have often not been moving in the same
direction. For further details, refer to Figures 3 and 4. Figure 3 indicates
the history of the dollar-denominated Nikkei Dow and Figure 4 indicates
the history of the New York Dow, both from the end of the War up to now.
Both indicate dollar-denominated monthly charts with the axes of prices
in a logarithmic scale. I will now look at the changes in both Dow values
in the two countries during the 40 years from the beginning of 1960 to
October 1999. For the purpose of comparing correlations, I divide the
period into four phases as defined by:
Phase 1 (I in Figures 3 & 4) 6 years from the beginning of 1960 to the end
of 1965;
Phase 2 (II in Figures 3 & 4) 17 years from the beginning of 1966 to the
end of 1982;
Phase 3 (III in Figures 3 & 4) 7 years from the beginning of 1983 to the
end of 1989;
Phase 4 (IV in Figures 3 & 4) 10 years from the beginning of 1990 to the
end of 1999 (For 1999, as of October).
In Phase 1, the New York Dow rose while the Nikkei Dow fell. The reason
for this disparity is found in the fact that, while the US economy was
enjoying a period of prosperity in the Sixties, Japan experienced a
medium-term correction stage called securities depression.
In Phase 2, the New York Dow showed no significant fluctuations over a
long period while the Nikkei Dow indicated a long-term up-phase. This
was caused by the US economy being in the long-term doldrums while in
Japan there was long-term high growth. The US down-turn was brought
about by the Vietnam War, the reduction in dollar value, chain-reacted
bankruptcies of savings and loan associations, rapid growth and collapse
of the two-tier market in New York, the socio-political disorder of the
Watergate scandal, and so on. On the other hand, the long-term high
growth in the Japanese economy was the result of a high marginal
growth rate. Growth started from zero after the last war, with a rise in the
geopolitical significance of Japan in the advance of the East-West cold
war, gradual and continued rise in land prices, the introduction of new
technologies from Europe and North America and the promotion of
Asset allocation in Japanese and US stock
markets by means of technical analysis
Summary of presentation to IFTA 2002 Conference By Hiroshi Okamoto
Figure 1
Figure 3
Figure 4
Figure 2
technological improvements by Japanese companies, comprehensive
corporative labour relations, political stability, and so on.
In Phase 3, both the New York Dow and the Nikkei Dow rose. This is the
only period after the War when both Japanese and US stock markets kept
pace with each other. However, the Japanese economy was in the grip of
a bubble and developed a more speculative, dynamic upward market.
This will be verified later, from a technical viewpoint, by using net
momentum which means the balance of the momentum of the New York
Dow subtracted from that of the dollar-denominated Nikkei Dow.
In Phase 4, the New York Dow rose while the Nikkei Dow fell. The opposite
trends were the result of long-term stable growth in the US and a rapid
collapse of the bubble economy in Japan. During this period, all the new
and old industries in the US showed a favourable performance. While old
enterprises promoted restructuring to improve their profit structures,
venture-capital organizations and other groups of enterprises entered the
stock market one after another. In the Japanese industrial world, on the
other hand, values of all the capital stock, including land and corporate
stocks, were abruptly reduced, and future corporate activities were greatly
curtailed. Moreover, many industrial sectors lost their growth potential
and many companies crashed. The Government was slow to introduce
measures to counter the down-turn and failed to implement structural
reform of financial markets and industry.
I will now move forward to the three years since November 1999 not
covered in Figures 3 and 4. In analysing this period, I have tried to develop
a universal methodology of technical analysis that involves a little more
technical and scientific analysis. I have concentrated on trend analysis.
We usually classify trend analysis into regular time-series analysis and
irregular time-series analysis.Briefly, the regular time-series analysis is
represented by that of moving average lines and the irregular time-series
analysis, by point and figure charts. In practical application, they involve
their own merits and demerits, and analysts may choose either to their
liking. I am going to consider the moving average line analysis and the
following is my concept of this analysis.
The moving average lines of the stock indices are plotted, as you know, in
a manner to place an averaged value over an averaging period at its end.
This method allows the lines to smooth initial series of values and, at the
same time, the lines have the effects of delay.The term effects of delay
is explained as follows: we draw an upward trend line by connecting low
prices when the market is in an upward trend; on the other hand, we draw
a downward trend line by connecting high prices while the market is in a
downward trend. Effects of delay means that the moving average line
can take the place of these upward and downward trend lines. Generally
speaking, classic trend lines have a defect in that they cannot be drawn
until the market proceeds to a certain degree. The new trend line that is
represented by a moving average line has the merit of drawing from the
start of the market movements.
On the other hand, the issue of delays in the moving average lines marks
a weak point of technical analysis. This is applicable, in particular, when
cycles are relatively small-scale in the market. Immediately after a reversal
of a trend is confirmed, if the market cycle is small, another reversal is
sometimes found there. This means the occurrence of a misleading signal.
I wondered if I could develop a moving average line having smoothing
effects and small delays (or less misleading contents), as a moving average
line such as that would be an ideal one. Now the technique that more or
less realises this ideal line is the Okamotos moving average line.
The moving average lines I have successfully devised are based on
statistical methods. Namely, I plot an averaged value, not at the end of an
averaging period, but at its centre. Taking an example of a nine-day
moving average, the day on which the averaged value is positioned is at
the centre of the nine days, or the fifth day. This method allows me to
smooth initial series of data values without fear of delays. However, this
method is not exempted from demerits. Since the nearest average value
falls on the fifth day, there are no average values for the remaining four
days. To fill in the blanks, I have found the following remedy. Use a
regression analysis to estimate future stock prices and strike average
values based on such estimated data.
Take an average of actual stock prices from the first to ninth days and
position it on the fifth day. This is the usual statistical way. For my
method, however, make linear regression of stock prices for five days,
namely, from first to fifth, and estimate stock prices for the four days along
the regression line. Then, take an average of the actual stock price for the
five days used in the regression analysis followed by the newly estimated
stock prices for the four days, and use the average value thus found as
that for the nine days to be located on the fifth day. In this way, we can
calculate a moving average line to the last item of the initial series of
values. It is the Okamoto style that prepares an average line by adding
one day after another to an averaging period and taking average values in
this way.
Now, have a look at Figures 5 and 6. The upper portion of Figure 5
combines the dollar-denominated Nikkei Dow, which is a monthly chart,
with a 48-month moving average line. The upper portion of Figure 6
combines the New York Dow for the same period with a 48-month
moving average line. Both are Okamoto-type 48-month moving average
lines. I believe you will find the average lines are not so much behind
actual stock prices in either figure. If I attempt to plot a 48-month moving
average line that is ordinarily used in the stock market, I arrive at Figure 7.
You will find a clear difference between Figure 7 and the upper portion of
Figure 5. In conclusion, Okamotos trend-line technique is characteristic of
smoothing the movements of stock prices with relatively small delays.
The lower portion of Figures 5 and 6 indicates the momentum of the
moving average lines shown in the upper one. The momentum in this
example represents ratios of the moving average lines changing from the
previous month. Since it shows changes from the previous month, it is
naturally located in the positive zone if the market trend is upward and in
the negative one if it is downward. Be sure that any changes in the
positive/negative signs will suggest trading timing for the markets.
Looking at Figures 8 and 9, the upper portion of both figures indicates
transitions in Dow average in Japan and the US. I have given a special
device to the lower one for the purpose of technical analysis. In other
words, it indicates the net momentum that means the balance of the
momentum of the New York Dow subtracted by that of the dollar-
denominated Nikkei Dow. The net momentums in both figures are the
same. Note that, in these figures, I adopt momentums compared with
those six months before, instead of those compared with one month
Figure 5
Figure 6
before and that the net momentums are based on data compared with
those of six months before. You will find that this processing has made
changes in the signs far more identifiable when compared with those in
Figures 5 and 6.
Generally speaking, momentums are used to find buying signals when
they shift into the positive zone and to find selling signals when they shift
into the negative zone. However, the net momentum has a different
meaning. Shifting into the positive zone suggests superiority of the US
market while shifting into the negative one favours the Japanese market.
The shift into the positive zone shown in the lower portions of Figures 8
and 9 means that we should sell Japanese equities and buy US ones, while
the shift into the negative zone means that we sell US equities and buy
Japanese ones. Therefore, the net momentum acts as a reliable indicator
for asset allocation between the Japanese and US markets.
Verification of the net momentum by applying past
data
Now, lets verify what degree of results we may secure if we should apply
the net momentum for reciprocal operations in the Japanese and US
markets over the past 40 years. For the verification purposes, I apply the
following trading rules:
1. Although shifts in the net momentum are confirmed at the end of a
month, we assume that trading is made at the prices prevailing at the end
of that month.
2. Ignore fees, interest, taxes, etc. related to the trading, and exclude them
from computation.
3. Use monthly charts since the beginning of 1960 for this verification
purpose by means of the indices of the dollar-denominated Nikkei Dow
and New York Dow.
4. Always start trading with buying and avoid short sales.
When taking an overview of the 40 years from 1960 to 1999, I found a
total of 22 cases in which net momentum crossed the zero line, as shown
in the data in Table 1. Out of the 22 cases, eleven were a shift from the
negative into the positive zone (namely, shifting portfolio allocation to the
New York shares) and the other eleven were a shift in the opposite
direction (namely, shifting portfolio allocation into Japanese shares).
Notes
1. Abbreviations N1 to N11 represent trading of NY Dow.
2. Abbreviations T1 to T11 represent trading of dollar-denominated
Nikkei Dow.
3. Unit in dollars for both NY Dow and Nikkei Dow.
4. Periods held are based on months.
5. The rates of profit and loss (converted into annual ones) are
expressed in percentages.
6. Price data based on gross data from Graphs 1 to 8.
7. Asterisk (*) indicates extremely short-term trading as a result of
delicate or unexpected movements in the market.
Conclusion
These 22 cases resulted in 16 profitable trades and 6 unprofitable trades.
In other words, the success ratio based on the number of cases was 72.7%
(16/22 = 0.727).
The time required for a net momentum to switch from one market to the
other was, on an average, 20.6 months or one year and a half or more, for a
total of 22 cases. This can be regarded as the average maintaining time of
a trend for a trading. This means that, once it is determined whether we
should be in New York or Tokyo, the investment funds remain in this
market, on average, for one and a half years. This seems to me reasonable,
judging from an average sight of 48 months for short-term business
circulation.
It should be noted that there were two misleading shift signals over a very
short term. These occurred in October 1985 in the New York market and
in March 1992 in Tokyo. Both of them occurred as a temporary
phenomenum in a long-term upward process and indicated a new shift in
the subsequent month, earlier than usual. The final shift was in July 1999
shifting from New York to Tokyo.
Annual
Date Stock Date Stock Periods
Rates of
rates of
purchased price sold price held
profit
profit or
or loss
1 loss1
N1 61.12 731.14 63.5 726.96 17 0.57 0.40
T1 63.5 4.32 63.10 3.77 5 12.7 30.48
N2 63.10 755.23 65.12 969.26 26 28.3 13.06
T2 65.12 3.94 67.7 4.10 19 4.0 2.52
N3 67.7 904.24 68.8 896.01 13 0.9 0.83
T3 68.8 4.73 71.1 5.83 29 23.2 9.60
N4 71.1 868.5 71.12 890.2 11 2.4 2.61
T4 71.12 8.07 74.3 15.83 27 96.1 42.71
N5 74.3 846.68 76.10 964.93 31 13.9 5.38
T5 76.10 16.01 79.8 29.54 34 84.5 29.82
N6 79.8 887.63 80.12 963.99 16 8.6 6.45
T6 80.12 33.92 82.8 27.52 20 18.8 11.28
N7 82.8 901.31 83.12 1258.64 16 39.6 29.70
T7 83.12 42.21 85.10 60.25 22 42.7 23.29
N8 85.10 1374.31 85.11 1472.13 1 7.1 85.20
T8 85.11 62.73 89.7 248.39 44 295.9 80.45
N9 89.7 2660.66 92.3 3235.47 32 21.6 8.10
T9 92.3 145.79 92.4 130.20 1 10.6 127.20
N10 92.4 3359.12 93.5 3527.43 13 5.0 4.61
T10 93.5 186.45 95.2 173.59 21 6.8 3.88
N11 95.2 4011.05 99.7 10655.15 53 165.6 37.49
T11 99.7 154.96 99.10 166.61 3 7.5 30.00
*
*
*
Figure 7
Table 1
Figure 8
Figure 9
Excluding these three cases, and using a total of 19 cases instead of the
above-mentioned 22, the average trading period is slightly prolonged to
23.7 months. If we exclude the three very short-term cases mentioned
above, the average trend-maintaining periods in Japan and the US
become almost equalized. They are 24.5 months in Japan and 22.8
months in the US.
When making further analysis of the periods in which trends continued,
periods continuing for 2 years (or 24 consecutive months) or more,
recorded a total of 8 out of the significant 19 cases, with four in Tokyo and
another four in New York. Periods continuing for one year (12 consecutive
months) or more recorded a total of 17, or 8 in Tokyo and 9 in New York.
The fact that trends continued for one year or more in 17 out of a total of
19 cases demonstrates that this technique is reliable. Therefore, I believe it
can be used to trigger signals for investment funds that are shifting assets
between the two countries.
The longest investment period lasted from November 1985 to July 1989 in
the Tokyo market, with the margin being 80.45% per year. This period
corresponded to an exceptional case where both Japanese and US
markets rose as described above. I will now look at the question of
margin (or profit rate to invested amount). When reviewing the profit rate
(converted into an annual one) produced by a total of 22 trading cases,
the average was 13.94%, with the highest at the above-mentioned latter
half of the1980s in Tokyo (or 80.45%) and the lowest from May to October
1963 in Tokyo (-30.48%). As a matter of information, negative rates were
found in a total of 6 cases, far below the 16 cases of positive ones.
Needless to say, these negative trading cases included the misleading
signals.
When reviewing the shift signals, negative trades occurred twice in the US
and four times in Japan. The reason why they occurred more in Japan is
because they included two trading cases after the collapse of the bubble
economy. My investigation of these two negative cases revealed an
extremely low -127.20% (per year) in the very short term from March to
April 1992, followed by -3.88% (per year) in the 21-month case from May
1993 to February 1995.
With reference to the trading in the 1980s, funds were shifted to the
Tokyo market even though the New York one indicated positive
momentum. This was a case of a misleading trade, in which funds were
shifted to New York for a short period: only a month from October to
November 1985. However, other cases produced substantial investment
results, namely, profits of 23.29% per year in 22-month trading from
December 1983 to October 1985 and 80.45% per year in 44-month
trading from November 1985 to July 1989.
We need to pay attention to the following fact: this technique backed by
net momentum suggested asset allocation always shift funds into New
York market during and after the collapse of the bubble economy in
Tokyo. Generally speaking, as a result, international fund managers
succeeded in protecting their funds from long-term downward markets in
Tokyo and, also, they could enjoy the long-term prosperous movements in
the New York market.
Changes on and after November 24, 1999
My next investigation covers changes on and after November 24, 1999. As
Figure 10 clearly shows, a signal suggesting a shift to Japanese shares in
July 1999 did not continue for long. In October 2000, net momentum
shifted again, therefore the period suggesting investment in Japan came
to an end in the 15th month and funds were again shifted into the US
market in October 2000. However, in August 2002, the net momentum
was converted once again, suggesting another shift into Japan.
The period from July 1999 to October 2000 lasted for 15 months, and the
period from October 2000 to August 2002 lasted for 22 months. Although
neither case involved misleadingly short-term tradings, net momentums
were converted more frequently than ever. In my opinion, it is high time
for Japanese shares to maintain relative superiority. I will explain the
reasons why.
By definition, the capitalistic economy is a system that uses human desires
for wealth as the prime mover for its development, and by nature, it tends
to go out of control. Since the experience of the US in the 1920s, we have
devised some mechanisms to control such runaways, including but not
limited to, the reformation of the Banking Law, Securities Law, and
Securities Exchange Law.
At the very end of the 20th century, however, people began to believe
that the market was an all-rounder. They were put under pressure to
further liberalise the financial systems and they forgot about past
experience. So they supported the gradual removal of such controlling
mechanisms that they had once welcomed. The enactment of the
Gramm-Leach-Bliley Act finally paved the way to complete liberalisation.
Since banks added security businesses to their conventional operations,
the financial system displayed signs of excessive growth, thereby causing
bubbles to appear once again. As a result, L.S.De-ism flourished, fraud
flew high, while morals diminished. Although the Bush Administration
enacted a corporate reformation act, this will hardly solve the problems.
In my opinion, more powerful, elaborate, controlling mechanisms should
be produced. Im afraid I may be too pessimistic, but I believe it will take
10 years before the US market fully recovers. In my view the same is
applicable to many countries that introduced the US model for promoting
their financial big bang.
What about Japan? Japan is also to blame in so far as it intended to cause
big bang by introducing an American model. However, Japan differs from
other countries in a number of ways. The first of these is that the bubble
economy started and collapsed 10 years earlier than in other countries,
with its economy remaining in the doldrums and the stock market being
inactive for the past 10 years. This means that the stock price level has
been sufficiently low and there isnt much room for further falls.
The second is that the Koizumi Cabinet has started reviewing its
economic policy in a forward-looking manner, though it is extremely
delayed. The third is that people are steady in the case of Japan. It is true
that more than ten years ago some individual investors were caught out
by the bubble economy and were considerably damaged in the final
stages. As is often told, individual financial assets in Japan are fairly
sufficient, reaching about five times the total market capitalisation of
Tokyo Stock Exchange. Individual investors in Japan are still too careful,
but it is anticipated that they will not endure the continuation of zero
interest rates any more.
If the relevant ministries and agencies take correct policies, including
drastic reformation of tax systems for securities, it is quite probable that
individual investors will rush into the securities market. The fact that my
net momentum theory has indicated Japanese superiority in these years,
I hope gives us a signal of new streams into the market. As I have already
suggested, it is the truth in the past that, if the sun sets in the US, it rises in
Japan.
This article is based on the IFTA test paper I prepared in autumn 1999 and
so for further background information, please refer to the IFTA Journal,
2000.
Hiroshi Okamoto runs his own consultancy business and took over as
Chairman of IFTA in January 2001.
Figure 10
Introduction
Since joining a Japanese bank six years ago I have been fortunate enough
to be introduced to the Japanese method of charting called Ichimoku
Kinko Hyo. My Japanese colleagues who are very familiar with this
method of analysis, have used it over a wide range of markets.
The Kanji, the Chinese character for Ichimoku, means at a glance, Kinko
means balance, while Hyo simply means charts. Sanjin Ichimoku was the
pseudonym used by a Mr. Goichi Hosoda who devised the method in the
1960s when trading stocks. The central concept is the trend of the market.
In a previous issue of the Market Technician (April 2001, Issue No 40) I
wrote an introductory article about Ichimoku Kinko Hyo charts. I will
therefore, outline very briefly the main principles of this technique before
going into detail about how this type of charting can improve profitability
when trading options. Anyone who would like a more detailed
introduction can refer to my previous article.
Daily candlesticks are used for the charts which means that the system is
geared to medium to long term strategies and is not suitable for jobbers
and day traders. We then analyse the candle charts for reversal patterns,
which I find are often clearer than those on bar charts.
Two moving averages are added to the daily candlestick chart: a nine day,
called Tenkan-sen, and a 26 day, called Kijun-sen. The number of days
used is based on the fact that in Japan they used to work a six day week.
There are, I believe, 26 working days in the average month.
The moving average does not use the closing price. We use the average
of the days range: high plus the low divided by two. This is probably a
truer indication of the days activity, particularly for markets where the
closing price is at some arbitrary time, like foreign exchange, and in thin
markets where the closing price may be manipulated.
The crossover of the two lines gives buy and sell signals as with
conventional moving averages. To these, the two lines that make up the
clouds are added. The first, known as Senkou Span A, is calculated by
adding the Tenkan and Kijun values and dividing by two. The line is then
plotted 26 days ahead of the last complete days trading.
The second line, imaginatively called Senkou Span B, is calculated by
finding the highest price of the last 52 days, adding to it the lowest price
of the last 52 days, and dividing by two. This is also plotted 26 days ahead.
So, although they have the same name, their construction is very different.
The clouds have a variety of uses and add a completely new dimension to
the chart. Firstly, if todays candle is above the cloud, the trend is for
higher prices. The top of the cloud is the first level of support and the
bottom of the cloud is the second level of support. From experience I
have seen that these really do often work, but one has to give them a little
leeway.
The opposite is the case when candles are below the cloud, with this
becoming the area of resistance. Very often the market seems to move
through the first support/resistance level and fails somewhere in the
middle of the cloud. When this happens we watch the shape of the daily
candlesticks to see if they give a reversal signal.
Clouds can be very useful in adjusting a basic trading position. Partial
profits can be taken or tentative new positions can be entered into
without waiting for the moving averages to cross.
The thickness of the cloud is also important. The thicker the cloud, the
less likely it is that prices will manage a sustained break through it. The
thinner cloud suggests a successful break is a lot more likely.
This gives an idea of when the market is likely to change trend. It gives
dates (usually three or four days around the central point) when there is
an increased chance of a successful move through the cloud area. The
distance between the cloud and the current price is not significant.
Chikou Span
The final line to be added is the Chikou Span. It is merely todays closing
price plotted 26 days behind the latest daily close. This is used in
combination with the latest candlestick. If Chikou Span is trading above
the candlestick of 26 days ago, then todays market is said to be in a
bullish long term phase. Conversely, if Chikou Span is trading below the
candlestick of 26 days ago, then todays market is in a long term bearish
phase. The same idea applies to Chikou Span and the clouds; if it is above
the clouds of 26 days ago, this suggests a bullish outlook and vice versa.
Finally, the position of the candlesticks and the clouds are also levels of
support and resistance for Chikou Span. These will give suggestions of
where todays support and resistance will lie.
Try to visualise it as follows: in a bull market Chikou Span and the clouds
provide a solid base, and above you is nothing but clear blue skies which
will not hamper your way up. Conversely, in a bear market, Chikou Span
and dark heavy clouds will grind you down and push you lower.
Option Examples: Strategies where options are bought.
This is a good example for a cautious investor who wants to buy an out of
the money option. In this example the investor anticipates that the
Australian dollar should increase in value versus the US dollar. The chart is
of the number of US cents needed to buy one Aussie dollar (the level here
is 0.5400, so 54 US cents). The higher the price, the stronger the Aussie.
Believing it should move higher, he therefore wants to buy an Aussie call
(the same thing as a US dollar put).
First check the cloud and make sure the candlesticks are above the cloud.
If they are not wait, as a lot of time value may be eroded as prices can
stick under the formation for several weeks. If they are nudging into the
cloud and the investor really cannot resist the urge to buy, choose a call
with a strike at the top edge of the cloud and preferably above it (to the
nearest round number as these are more actively traded and therefore
more keenly priced) for example, the 0.5500 calls. As prices break above
the top of the cloud, they are likely to start moving quite quickly,
increasing implied volatility and thus adding value to the option.
Option strategies using Ichimoku Kinko clouds
Summary of presentation to IFTA 2002 Conference By Nicole Elliott
Australian Dollar
Sterling/dollar with clouds
Cloud made up of the difference
between Senkou Span A and Senkou
Span B
daily candlestick
Chikou Span
Nine day moving average
(Tenkan-sen)
This call can be held until expiry so long as prices do not break below the
bottom of the cloud. If they trade down below this line, it will probably be
worth selling out the option in order to recoup some time value and
possibly higher implied volatility. Note that, as and when prices move
higher, so does the cloud. It continues to provide support as the market
rallies and can be used as a trailing stop. Many investors do not think
about selling their options, especially in-the-money ones. But if you want
increased profitability you should re-assess positions continually to make
sure you have the best strategy for current market conditions.
In my next example, an investor wants to buy a put on the dollar versus
the Norwegian krona in the expectation that the rate will hold below the
cloud formation. This rate is quoted the European way, i.e. as Krona per
US dollar, so the lower the rate, the fewer krona are needed to buy one US
dollar. Ideally, the cloud should be thick and not have the lines crossing
over within the next 26 days. This is not quite the case in this example but
it is difficult to find perfect examples in current markets and I always
prefer to use up-to-date examples rather than historical ones. It is also
important to check that Chikou Span (the grey line) is below the candle of
26 days ago and below the cloud in this case NKr 7.5000. The investor
then buys a put with a strike just below this level, thereby increasing the
chance of buying an option that is likely to move into the money quickly.
If the investor is correct, the two cloud levels should come lower over the
life of the option. This time the upper level is used to cut the position to
minimise premium losses.
A similar, if more elegant, strategy to buy options can be achieved with a
knock in, which tends to be a lot cheaper than a conventional option. A
knock in is an option that only comes into existence when a pre-agreed
price level is reached. Premium is paid up front, on the day of purchase,
but if the knock-in level is not reached it never becomes a live option.
For calls, the knock-in is usually below the current price and well below
the strike price and vice versa for a put.
An investor who is bullish of the US dollar versus the Thai baht (the higher
the price, the weaker the baht), could do the following: buy an out of the
money call with a strike at the upper edge of the cloud, say 42.500. A
level between the Chikou Span and the cloud crossover, which is also
below the current price, would be used as the knock in price, say 41.750.
A minimum of one week, up to a maximum usually of one month
should be used for the knock-in period for an option that has three
months to expiry. The option is therefore much cheaper than a
straight call as the market a) may never drop to the knock in rate
before rallying, or b) may reach this level after the knock-in period has
expired (and so the option never comes into existence).
A similar strategy would be a reversal knock in. Assuming we are
currently below both levels of the cloud, the knock in could be at the
lower cloud level and the strike above the top of the cloud. While
neat, this strategy would not really save you very much money and
certainly not nearly as much as using the standard knock in that was
illustrated above.
A knock out option strategy would again make the option slightly
cheaper. This is an option which exists from day one, but then ceases
to exist or dies if a pre-determined price is touched.
In the next example I looked at the Singapore dollar versus the US
dollar; the lower the rate, the stronger the Sing. dollar.
Because the current price is below a decent-sized Ichimoku cloud I
would suggest the following strategy. Buy an at-the-money put on the
US dollar (a call on the Sing) at 1.7400. Use a level well above the
upper edge of the cloud and above the Chikou Span as the knock out
level, say 1.7700. So, if the market went against the investors strategy,
his option would cease to exist as prices break above the top of the
cloud. The most important thing is that the knock-out makes the
option cheaper to buy in the first place. In the event the US dollar
rallied against the Sing. dollar and so this trade was effectively killed
off.
It may seem strange to suggest a loss-making strategy, but what I am
trying to point out is that cutting losses is just as important as creating
profit-making situations to enhance returns. Ichimoku charts help to
decide sensible stop-loss levels which avoid day-to-day noise in the
market.
The last strategy involving only buying options. This is a Window
Knock out/Knock in which capitalises on the timing aspect of options
and Ichimoku. Windows are options where the knock in and/or
Thai Baht
Norwegian Krona
Singapore Dollar
Japanese Yen
knock out elements are shorter than the expiry of the option and are
for a pre-selected window of time, say a particular fortnight in the first
part of the life of the option. These are even cheaper than straight
knock-ins/outs in that not only must the trigger level be hit but it
must be hit within the right time frame.
To illustrate this example, we will look at the US dollar versus the
Japanese yen, again quoted the European way as yen needed to buy
one dollar: the higher the rate, the weaker the yen.
In an ideal world it is nice to see sharp price swings initially as these
trigger the knock-in (but might just kill it dead too!), followed by
steady moves later on where you dont have to worry about your
option unexpectedly expiring on you.
The idea is that, ahead of the cloud becoming very thin, the investor
buys the option assuming that there will be fairly sharp moves at the
thin point and eventually a change in trend. Once the new trend has
been established, one wants to run the trade and not worry about
getting stopped out. In this example I have assumed that we shall be
getting some very sharp moves around mid-October, and that we shall
eventually get a turn in the long term trend and that dollar/yen will
eventually move up towards 130.00 around the year-end.
The key element of this strategy is that we want to buy a three month
dollar call as our long term view is for higher prices. Say a three month
at-the-money call at 122.00. Why here? This level is above the top of
the cloud and just above Augusts high at 121.50. Because implied
volatility is likely to increase in mid-October, I have taken the view that
it is better to buy now rather than wait and have to pay more
premium.
The next step is to reduce the cost which I can do via a knock-in for
the two weeks around the 10th October, which is the thinnest bit of
the cloud. It is usual to put a knock-in a bit above the thinnest bit of
the cloud as a) you should not be too greedy and b) the knock-in is
saving such a lot of money that there is some leeway on the choice of
trigger price. So, above 118.00 and lets settle for 119.00.
As for a knock-out, I think that if dollar/yen broke to a new low for the
year, I should probably abandon this whole idea, so lets add a 115.00
knock-out lasting for the first month of the option. Again this will
reduce the premium I will have to pay on day one when I enter into
this trade. Premiums are so much lower with these add-ons because I
am in fact giving away optionality/betting against the trend. The cost
of this strategy is as follows: A straight three month 122.00 call would
be 1.8%, i.e. a percentage of the amount you want to do. So on one
million dollars that would cost $18,000.
The same strategy using a two week knock-in at 119.00 for the middle
two weeks in October reduces the cost of the call to 0.32%, $3200. To
the above we can add a one month knock-out (for the first month) at
115.00, reducing the cost of the option yet further, to 0.16%, $1600.
Less than one tenth of the price of a conventional call, which is not an
inconsiderable saving. Furthermore, the rate of return relative to
money tied up is dramatically higher. The result is greatly enhanced
profitability.
Strategies involving the sale of options
So far we have just considered strategies that involve buying options, but
bankers are more likely to be selling options. This is banks natural
business; we tend to buy options only to cover existing positions, to
reduce exposure, or as part of a more complex trade. Selling is a steady if
tricky business and I have heard it likened to picking up pennies in front
of a bulldozer.
First, selling a call to an investor.
Decision one: where to pitch the strike? Usually the investor decides,
but the grantor can increase or decrease the level of implied volatility
depending on whether he really wants to pick up premium at the
investors level. Strikes at new highs and new lows tend to be slightly
more expensive but, as fewer Western people know where the clouds
are, we can use these as well as new highs and lows.
Strikes at the top of the cloud could and should be more expensive,
while those within the cloud can be pitched more cheaply. This is
because the market is likely to get stuck inside the cloud (if it is thick),
using up time value. Theta, time decay, is the option sellers friend. If
only all options sold expired worthless.
Decision two: when to hedge the call as it moves into the money.
Assuming we have sold a 0.4800 call on the New Zealand dollar (put
on the US dollar). Premium received gives us a cushion, but we should
look to start hedging on a daily close above the upper cloud line.
Once the cushion has been exhausted then these are usually hedged
on a sliding scale based on the delta and the expected vega.
Ichimoku is good for trending markets and predicting turns in the
trend but can it be used in sideways markets? In this example of the
Euro/Swiss franc, we have a market that has been trading broadly
sideways for some time (the rate has traded between 1.4400 and
1.4900 for the whole of the year) and is likely to continue trading in
this way as it is neither above nor below the cloud.
We could sell a straddle (a call and a put with the same expiry and the
same strike) to pick up premium, with the strike at the mean rate of
the period, 1.4650. The option premium received would give us
enough cover to allow for several moves around the central rate. Brief
moves into the money, either the call or the put, are covered by the
option premium received for both the options.
However, based on Ichimoku, I would suggest selling a strangle
instead. Pick a call with a strike above the highest cloud for the period
observed, 1.4950, and put with a strike below the lowest Chikou Span
level, 1.4450. The premium received would be a lot less, but I think
that running the position would be a lot less stressful. Time value will
steadily erode until the option expires worthless. Premium income
equals net gain to grantor. Note that these types of options are used a
lot in the interbank market, and participants will go to great lengths to
protect the options they have sold so as to ensure they expire
worthless.
New Zealand Dollar
Euro/Swiss
Another strategy for a market that is likely to go nowhere over the
next month or so would be a double no touch. Note that as a rule of
thumb, in FX circles, we tend to grant plain vanilla options (simple
basic strategies) in low volatility environments, and exotics (option
strategies with all the ding-dongs) in high volatility situations. This
saves the seller money when the market is flying about as knock outs
are more likely to be triggered, thus making the option worthless.
Anyway, a double no touch means that the options remains alive so
long as neither a pre-established upper or lower level have traded.
The seller of the strategy should chose touch levels that are far
enough away to satisfy the buyer, but preferably inside the cloud or
recent high points/low points. So for Euro/Swiss we could try and sell
a double-no-touch with an upper level at this summers high of 1.4800
and a lower level at 1.4450. With a little luck these levels are likely to
be hit, again killing the option leaving the vendor with the premium
and no position to run or worry about.
Prices are still below a nice fat cloud and the trader thinks they will
hold below here and move lower again. However, the cloud structure
has deteriorated so there is a chance that we might break higher. I
would suggest selling an at-the-money call and buying a second, out-
of-the-money call, for the same expiry. Premium received will be more
than that paid out, making this a good way to work with clouds. The
call you sell will be the one at the bottom of the cloud. The premium
received should be more than enough to cover you until the top of
the cloud, the strike where the second call is bought. The market gets
stuck in the middle; time is wasted and you have made a profit. But, if
the trend really does change, then one for one the option you bought
will cover the losses on the option you granted.
Variations on this idea could include buying twice as many out-of-the-
money calls. This would, of course be more expensive and to be able
to do this the cloud would have to be a lot thicker (and the strike
prices further away from each other). In this case, if the market breaks
higher, then the first call covers the losses on the call that was granted.
The second call makes the money as a speculative position.
Selling a Calendar Spread
Here, instead of using nice fat clouds, we are looking to the point at
which the Senkou Span lines cross. The US dollar against the Swedish
krona, quoted the European way as krona to the dollar. Here we are in
late August and September and the market pushes up against the
cloud and pulls back. The cloud is expected to halt further rallies, but
not forever. The thinness suggests a break higher by November.
Strategy: sell a three week call using the top of the cloud as the strike,
9.5000. This option will hopefully expire worthless as the market will
not have broken higher by then. Timing is obviously key here, with the
choice of strike a secondary issue. Premium received can be used to
fund part of another call at the same strike, or all of a call at a higher
strike. But this second option starts two weeks later and expires two
weeks after the first one. To make it more affordable, it too could have
a knock in (say at 9.1000) before it gets going.
Another idea for a market that has very fat clouds with a thin bit in the
middle, when you anticipate that the market will change direction, is a
box trade. Buy a call at the top of the cloud 9.5000 again. Fund it by
selling a put below Chikou Span 9.1000. The premium on the two
would be roughly equal.
A more complex variation on this idea would be selling a butterfly
spread. For this example I will look at the Euro. The clouds are not as
fat as I would like, but I prefer using current examples. Anyway, we
will sell a 0.9900 call, buy two 1.0000 calls and then sell a 1.0100 call to
help fund this little gem, all for the same maturity. This trade is market
bullish and volatility bullish, with positive delta and gamma. The two
par calls will cover any losses on the first call sold and, with a little luck,
the other call sold will expire before moving into the money.
Most trading revolves around trading bands, trends and timing.
Ichimoku captures all these ideas in a very graphic and immediate
way. But more important, option trading requires even more thought
and attention than outright positioning. All too often investors
become tremendously complacent, buying an option because the risk
is perceived to be lower; happily hanging on to the option, especially if
it is in-the-money, not realising they may now hold an outright
position or an inefficient strategy. Trading is something to be
approached fresh every day, with an open mind and a sensible, flexible
strategy. Every day check the trend and whether the original view is
still right. Check implied volatility and, if it is ridiculously high, consider
selling out the option. Understand whether you want a high or low
delta. Time decay, which accelerates dramatically in the last few days
in the life of an option, can be used to your advantage. Option trading
is not easy but Ichimoku can help enhance your returns.
Nicole Elliott is a technical analyst with Mizuho Corporate Bank in
London. The banks name may not be familiar to you as it is only nine
months since it was incorporated. It is the result of the merger between
the Industrial Bank of Japan, Fuji Bank and Dai Ichi Kangyo Bank. It is
now the largest bank in the world in terms of assets.
Silver
Euro
Swedish Krona
I have clearly made a mistake in calculating the time zone for a Great
Bear Market (GBM) low. I assumed that, since the mania was
technology-related, the high to use was March 2000, but the
September-November 2002 zone only produced GBM-sized declines
in France and Germany, and the overall configuration in the US and UK
did not look convincing. Perhaps more importantly, the indicator
readings on the October-November recovery did not confirm a new
bull market. Furthermore, the FT World Index reconfirmed on the
downside in late January, as Chart 1 illustrates.
If it is not March 2000, then it is September 2000 where calculations
should start. Apart from the fact that the FT World Index peaked then
(FT All-Share and CAC 40 on the 4th and NYSE on the 11th), my Elliott
count for the S&P 500 treats its 31st August high as ending the bull
market with a failed fifth wave Diagonal Triangle. Extrapolating the
GBM time periods from 4th September produces a time range of 6th
February 2003 through 6th July. This can be narrowed down further.
In Elliott terms, I believe that an (A)-(B)-(C) pattern has been unfolding
since September 2000. It is therefore worth looking for a low where
(C) equals (A) in time terms. For the NYSE, this is Saturday 29th March -
see Chart 2. For the FT World, CAC and UK All-Share indices, it is
Saturday 5th April. Broadly, therefore, a low could fall in the last week
of March or the first week of April.
In addition, if you look at a range of indices and Fibonacci ratios, there
is one further cluster of dates worth watching: 26th June to 12th July.
The appearance of this second cluster is interesting for two reasons.
Firstly I believe that the decline from the November 2002 high may
sub-divide into two downward legs, so if the overall configuration
does not look right by the end of this month, it may by July. A more
important reason is that, if you look back at the history of global
market lows over the past thirty years, it is quite common to see
different countries producing final closing lows months apart, as the
table reveals. If indeed a Great Bear Market bottoms this year, it may
be drawn out globally. The table highlights well where September,
October and November get their reputations. I am hoping/expecting
that 2003 will be different.
Still a Great Bear Market?
By Peter Beuttell
330
300
250
200
150
110
F M A M J J A S O N D J F M A M J J A S O N D J
30%(R.H.SCALE)
Source: DATASTREAM
RSI at 30 with a
falling 200-day
average warns of a
resumed downtrend.
Chart 1
FT WORLD INDEX & 14-DAY RSI
240
200
150
100
50
5
FTSE W WORLD - PRICE INDEX
14-DAY RSI(R.H.SCALE)
200-DAY M.A.
,
,
*
*
29.03.03
375 days
(A)
(B)
375 days
Chart 2
7500
7000
6500
6000
5500
5000
4500
4000
2000 2001 2002 2003
Source: DATASTREAM
NYSE COMPOSITE
110
105
100
95
90
85
80
75
70
US
UK
France
Chart 3
J F M A M J J A S O N D J F M
S&P 500 COMPOSITE - PRICE INDEX
FTSE ALL SHARE - PRICE INDEX
FRANCE CAC 40 - PRICE INDEX
Source: DATASTREAM
MARKET COMPARISONS - 1994/95
1974 1987 1990 1994 1998
Dow Jones 06.12.74 19.10.87 11.10.90 04.04.94 31.08.98
S&P 500 03.10.74 04.12.87 11.10.90 04.04.94 31.08.98
UK 13.12.74 10.11.87 24.09.90 24.06.94 05.10.98
France 26.09.74 29.01.88 14.01.91 13.03.95 08.10.98
Germany 07.10.74 10.11.87 28.09.90 28.03.95 08.10.98
Japan 09.10.74 11.11.87 01.10.90 29.06.95 09.10.98
Hong Kong 10.12.74 07.12.87 28.09.90 23.01.95 13.08.98
At the time of putting this issue to press, military action in Iraq seems
increasingly inevitable. Back in October at the IFTA conference, Ralph
Acampora had already anticipated this situation and he and Edward Keon
had done some very interesting work on what happened to the Dow
Jones index during previous periods of conflict since the Second World
War.
On each of these occasions, the market fell sharply after the incident that
triggered the action occurred but rallied once the riposte got underway.
Ralph Acampora is Director of Technical Analysis and Edward Keon is Director
of Quantitative Research at Prudential Securities.
World War II
Pearl Harbour
September 11th, 2002
Sputnik
Cuban Missile Crisis
Gulf War
The pattern of war
By Ralph Acampora and Edward Keon
Korean War

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Last Octobers IFTA conference was heralded as a great success.

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