Issue 36

Apr-Jun 2010
The publication for trading and investment professionals
www.technicalanalyst.co.uk
Exploiting Market
Mispricing with
Castlestone
Management
News and Views
Awards
Technical Trading
The latest stories on technical

analysis and behavioural finance
from around the world
Winners and finalists at The

Technical Analyst 2010 Awards
ceremony
Using the Rex Oscillator to find

turning points in the markets
Welcome
In this edition we speak to London based hedge fund
Castlestone Management about how they look to exploit
market mispricings as part of their trading and investment
strategy. This provides a fresh perspective on how to view
deviations of prices from fair value using a combination of
technical and fundamental analysis. Given the recent calls that
US and UK stocks may be peaking, we also look at the Rex
Oscillator, a less well know indicator that has a good record
at anticipating major market turns in the stock market.
Matthew Clements
Editor
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Apr-Jun 2010
THE TECHNICAL ANALYST
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Contents
Apr-Jun 2010
The publication for trading and investment professionals
www.technicalanalyst.co.uk
Exploiting Market
Mispricing with
Castlestone
Management
News and Views
Awards
Technical Trading
The latest stories on technical

analysis and behavioural finance
from around the world
Winners and finalists at The

ceremony
Using the Rex Oscillator to find

turning points in the markets
COVER STORY
Interview:
35
Exploiting Market Mispricing with Castlestone

Management
MARKET NEWS AND VIEWS

TECHNICAL TRADING
The Rex Oscillator
06
10
The TNCP Triangulation Indicator: Part 2
19
Market Cycles and Business Cycles
AWARDS
The Winners at the Technical Analyst 2010

Awards Ceremony
INTERVIEW
Leon Diamond, Castlestone Management in London
15
25
10
Trading the Gold Market
15
Behavioural Investing
22
25
35
RESEARCH UPDATE
41
TRAINING DIARY
44
Apr-Jun 2010
The Rex Oscillator
04
Trading The Gold Market: USD vs EUR
Behavioural Investing
06
Market News and Views
MARKET NEWS
AND VIEWS
BOB PRECHTER IN
LONDON
Bob Prechter of Elliott Wave
International has joined the growing ranks of analysts forecasting
an imminent market top in
stocks. Speaking in London in
February he described stocks as
being in a serious bear market.
Explaining the current situation
for the S&P500 and Dow,

Prechter said the market is in a
clear 5th wave structure and the
current rally probably represents
the second shoulder of a headand-shoulders top. This, he says,
signifies that a very sharp decline
in stocks is due.
STOCKS, STARS AND THE MOON

Bill Meridian of Cycles Research has
published his latest book, The
Predictive Power of Eclipse Paths
which details how astrology can be
used to predict major world events.
Meridian currently uses astrology
and lunar cycles to forecast financial
markets. His book is available from
billmeridian.com.
Using astrology and lunar cycles
to predict financial markets does
have history in print. In 1991,
Welles Wilder published Delta
Phenomenon, a book that reportedly sold huge quantities at $175
per copy.
Rob Mitchell, a US-based software developer, has recently published some work on lunar cycles
and claims that buying the S&P500
around the 23rd or 24th of the lunar
month and holding it until the 4th of
the following month will yield superi-
or returns. Indeed, in 2003, the

Atlanta Federal Reserve even published a paper on the subject and
found that geomagnetic storms
(caused by lunar and solar activity)
had a negative affect on stock

returns and that returns were much
higher when geomagnetic activity
was particularly quiet.
THE BRADLEY MODEL: DOW DOWN TO 6500

According to a US hedge fund, the
Bradley market cycle model is predicating a massive drop in US stocks
starting the second week of April
and lasting until October. This is
expected to see the Dow fall
towards 6500. The possibility of the
market being at a top now is supported by extremely positive market
breadth at present.
4
The Bradley model was devised

by Donald Bradley and published
in his 1948 book, Stock Market
Prediction The Planetary
Barometer and How to Use It.
The model produces signals called
Bradley Turn dates. These give the
date of a stock market turn, but
not the direction. One high-profile
fund manager who pays close
Apr-Jun 2010
attention to the model is Marc

Faber of GloomBoomDoom.com.
He says the Bradley does have a
track record in predicting turning
points and so the strong signal
being sent at present should be
taken into account when assessing market direction for the year
ahead.
Market News and Views
OTHER NEW BOOKS
James Clunie, an analyst at

Citigroup in London, has written a
new book entitled, Predatory
Trading and Crowded Exits
(Harriman House) that provides a
guide to understanding, identifying,
(and hopefully exploiting) periods
when market prices move away
from their fair value.
PRESIDENTIAL CYCLE
SEES 2010 STOCK
CORRECTION
David Linton of software provider

Updata has produced Cloud
Charts, a new book describing in
detail how to use the Ichimoku
charting technique. Although there
have been other books on
Ichimoku, most notably bu Nicole
Elliott at Mizuho Bank, this is by far
the most comprehensive on the
subject. Clear explanations and high
quality charts make this an essential
read on this increasingly popular
technique.
Sy Harding, author of the Street

Smart Report, has warned in a
recent report that the second year
(2010) of the 4-year US presidential
election cycle is the time to look for
a major correction in the stock market. He points out that unpopular
government policies at the beginning
of a presidents term take effect in
the second year which is negative
for stocks. Markets then rally as
economic policies kick in that are
designed to favour re-election.
Harding says that the prospect of
higher interest rates and cuts in government spending this year maintain
the prospect of a textbook scenario
where stocks will decline sharply.
LOOKS OUT FOR SPRING

RALLY IN STOCKS
Ryan Detrick, chief technical analyst
at Schaeffer Investment Research,
has highlighted the tendency of
stocks to rally during the spring on
Albert Herters blog. Over the past
30 years, the S&P500 has rallied on
average 1.5% in April and 1.5% in
May making them the best performing consecutive months of the year.
INVESTORS NOW SUBJECT

TO BEHAVIOURAL BIASES
Bob Van Munster, head of Tyndall
equities at Sydney-based Tyndall
Investment Management, says
that anchoring and adjustment
and aversion to ambiguity are
two behavioural biases likely to
impact stock market investing this
year. These biases mean that
investors may have insufficient
diversification in their portfolio,
both in terms of stocks and also in
the range of asset classes held
said Van Munster. This also means
that investment decisions will
often be based on the past
returns of asset classes even
though investing in last years best
performing asset class has historically proven to be a poor strategy.
Apr-Jun 2010
Technical Trading
Apr-Jun 2010
Technical Trading
THE REX
OSCILLATOR
INDICATOR FOCUS
The Rex Oscillator was developed by a trader, Eduardo

Moreira, while working at BTG Pactual in Brazil in 2001. He
now works in asset management at Sao Paulo-based Plural
Capital. The Rex Oscillator measures a price bars close relative
to its open, high, and low. It is best described as a momentum
indicator because it assists in trend-following analysis.
The indicator works by assuming that a wide spread between
the closing price and high of a given bar is bearish for prices
and that a wide spread between the closing price and low is
bullish. In other words, it looks for closing prices that are far
above and below the low and high of the day: a strong close
reflects positive momentum whereas a weak close reflects
negative momentum.
The Rex Oscillator is commonly created using a moving
average of the true value of a bar, which is equal to:
3 x Close (Low + Open + High)
Apr-Jun 2010
The RO is constructed on a scale above and below a zero

line. When it crosses above zero it suggests momentum is
positive and when it crosses below the zero, this produces a
bearish signal.
Katie Stockton is the chief market technician at
Connecticut-based hedge fund, MKM Partners. She uses
the Rex Oscillator extensively in her market analysis of
stocks and foreign exchange. In a study of the Rex
Oscillator, spanning the period from early 1990 to early
2010, Stockton found that the S&P500 Index fell for about
two-thirds of the weeks that the oscillator was negative and
rallied for about two-thirds of the weeks that it was
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Technical Trading
THE INDICATOR WORKS BY ASSUMING THAT A WIDE SPREAD

BETWEEN THE CLOSING PRICE AND HIGH OF A GIVEN BAR IS
BEARISH FOR PRICES AND THAT A WIDE SPREAD BETWEEN
THE CLOSING PRICE AND LOW IS BULLISH.
Figure 1.
positive. The average weekly loss was 2.5% and the average
weekly gain was 1.9%.
Figure 1 shows how the RO gave a very strong sell signal
in April 2009 for the USD Index. This was followed by a buy
signal in November of the same year. The RO usually generates strong signals only intermittently. This year saw a major
signal in January for US stocks. Stockton noted that the RO
was signalling a decline in the S&P500, its first sell signal

since March 2009.
Figure 2 illustrates how the RO gave an early sell signal for
the euro in July 2008 for EUR/USD. This signal came before
the break of the 40-week moving average and was followed
by a further sell signal in December that again came before
the break of the moving average.
Figure 2.
Apr-Jun 2010
Trading The
Gold Market:
USD vs EUR
Technical Trading
By Lynnden Branigan,
Chief Technical Analyst, Informa Global Markets
A twelve-week corrective dip in gold, as commonly benchmarked against the US dollar, has prompted a test of a 16month bull channel. However, looking away from the precious metals status as a hedging tool against USD fluctuations and inflation, we take note that there have been new all
time highs recently seen against the core European currencies.
Since the initial sell-off from the 2 December 2009 peak
stalled on 22 December, the value of gold, when priced in US
dollars, made a lower high on 11 January before resuming a
downward path to a new closing low at 1063.30. Meanwhile,
over the same period, gold in terms of the Euro extended
10
Apr-Jun 2010
THERE IS AN ISTOCK IMAGE

FOR PAGE 8. SENT THE
NUMBER OVER WITH THE
ARTICLE.
its longer-term bull run off the 22 December low to set new
all time closing highs in February and March of this year
(Figure 1).
Technical Trading
Apr-Jun 2010
11
Technical Trading
Figure 1: Gold priced in Euros daily chart
Further more, outperformance of gold can be seen relative

to the other two core European currencies, the British Pound
and the Swiss Franc. Despite the fact that Sterling did not
bottom out until late January at 673.21, it has since accelerated to post new highs (Figure 2).
Figure 2: Gold priced in GBP
Gold as an asset class

Along with underpinning golds longer-term attraction to
investors, this apparent anomaly underlines an aversion to
core European currencies. At the centre of this is credit
default risk in the Euro states and the UK which is having a
12
Apr-Jun 2010
knock on effect with Switzerland. The development of gold

as an asset class in its own right, along with easier investment
access via Exchange Traded Funds (ETFs), has provided a
more liquid environment in which to draw investment away
from the low carry of the Swiss Franc into the safe haven status of gold.
It is further interesting to note that the Bank for
International Settlements (BIS) identifies a 50% rise in precious metal contract volumes driven by a doubling in gold
contracts on Chinese exchanges. Allied to ETFs and other
structural changes, this further enhances the breadth and liquidity in the gold markets and substantially widens its
investor appeal. The World Gold Council puts identifiable
investment in gold up 7% least year versus 2008 and within
this ETF demand up by 85%.
Golds status versus the USD has been largely impacted by
the Chinese influence. Being the biggest consumer of gold
after India, its State Administration of Foreign Exchange is
openly wary of higher prices affecting its domestic consumer
demand for the precious metal. Additionally it continues to
support its export industries with USD purchases in order to
maintain a week Yuan hence slowing the ascent of gold in
USD terms.
Using Fibonacci for gold in Euros

Using the Euro as the lead market of this latest push into new
all time highs in gold, we can employ Fibonacci projections
to extrapolate potential upside targets. We would expect continued gains to point towards 858.00 (0.618 of 649.00/808.66
projected off 759.40), with longer-term strength bringing in
to focus the psychological 900.00 area. This also marks an
equality projection of 534.30/785.30 measured off the
649.00 reaction low.
Technical Trading
Figure 3: Gold priced in USD daily chart
A rising trendline off the 11 September 2008 low at 534.30

can be used to define a bull channel which currently caps the
market at 925.50 (note that the equality projection of the earlier mentioned Fibonacci projection sequence of the
649.00/808.66 up-move off the 759.40 low lies at 919.00).
Of immediate importance on the downside is the 19
January, former peak at 797.10. Losing support there exposes the 773.80 higher low which shields the key 759.40 reaction low. The market needs to close below the latter to break
Key Technical Levels Gold priced in Euros
the longer-term trend for higher highs and higher lows. This
would then target channel support at 732.30, the equivalent
of which is at 1101.25 on the USD/Gold chart.
Underperformance of gold in USD

Recovery gains off the 8 February low (Figure 3) need to sustain a close over the 11 January, 1152.15 closing high to confirm a resumption of the longer-term bull trend and enable a
re-test of the all time highs of late December 2009.
RESISTANCE
925.50
Tentative bull channel top
900.00
Psychological & equality projection of 534.30/785.30 measured off the 649.00 low
919.00
858.00
Equality of 649.00/808.66 measured off 759.40
0.618 Fibonacci projection of 649.00/808.66 measured off the 759.40 low
SUPPORT
797.10
19 January 2010 former peak
759.40
23 December 2009 key reaction low
773.80
732.30
22 January 2010 higher low
Rising trendline support off the 11 September 2008 low
Informa Global Markets obtains information for its analysis from sources it considers reliable, but does not guarantee the accuracy or completeness of its analysis or any information contained therein. Informa
Global Markets and its affiliates make no representation or warranty, either express or implied, with respect to the information or analysis supplied herein, including without limitation the implied warranties of fitness
for a particular purpose and merchantability, and each specifically disclaims any such warranty. In no event shall Informa Global Markets or its affiliates be liable to clients for any decision made or action taken by the
client in reliance upon the information or analyses contained herein, for delays or interruptions in delivery for any reason, or loss of business revenues, lost profits or any indirect, consequential, special or incidental
damages, whether in contract, tort or otherwise, even if advised of the possibility of such damages. This material is intended solely for the private use of Informa Global Markets clients, and any unauthorised use,
duplication or disclosure is prohibited. This material is not a comprehensive evaluation of the industry, the companies or the securities mentioned, and does not constitute an offer or a solicitation of an offer or a recommendation to buy or sell securities. All expressions of opinion are subject to change without notice.
Apr-Jun 2010
13
Technical Trading
BEHAVIOURAL INVESTING
Alida Carcano of AD Advanced Finance in Switzerland discusses how behavioural finance can, and cannot, be used to help in making investment decisions, and how the credit crunch has taught us more about the behavioural
biases of investors.
Do you believe that markets are always inefficient?
I do believe that markets are quite efficient but inefficiencies exist in the short to medium-term and/or in specific market niches; they then tend to disappear in the
medium to long-term. BF can exploit these inefficiencies
opportunistically. I think it is important to notice that, not
only in finance but generally speaking in our everyday
life, emotion and instinct are increasingly being recognised as natural principle, while the long-standing
supremacy of rationality is coming under fire.
Does BF completely disprove the Efficient Market
Hypothesis?
I think that BF actually proves that markets are efficient
because in the medium/long-term market prices are
Apr-Jun 2010
much less influenced by psychological factors. Take for

examples phenomenon like overreaction: it is a shortterm inefficiency that tends to disappear over time (more
or less quickly according to several market factors)
Are markets more inefficient at some times than at
others? If so, when?
This is a good moment to ask the question. After experiencing markets movements over the last 18 months,
and being in the middle of an extremely sever economic crisis, the obvious answer seems to be that markets
are more inefficient when everything goes wrong. It is
also interesting to ask if markets are more inefficient
when volatility increases or visa versa. Somehow there
is a vicious circle effect at play. As soon as market players become more reliant on non-rational (or less
15
Technical Trading
rational) factors, volatility tends to increase; as soon as

volatility increases, market players become more nervous and prone to irrational behaviour.
What is the relationship between technical analysis

and BF? Do charts provide the best tangible reference to BF effects?
Could a better knowledge of BF have prevented the

dot com and credit bubbles?
I do use charts, but I think that the best tangible reference

to BF is provided by intestors behaviour. For example,
when I discuss with a client their portfolio, the client has
a natural tendency to spend much more time discussing
a single equity position on which he has a significant unrealised capital gain or loss, than his asset allocation even
if that equity position only represents 1% of his wealth.
If he is losing significantly, he will ask Why did you
buy it? And why didnt you sell it when you saw it was
going the wrong way? If he is gaining significantly, he
will say lets sell and take the profit. In this attitude
there is more than a single irrational behaviour. It is very
tangible, but still difficult to avoid.
The problem with BF is the following paradox: we

know it exists, we know it influences market movements but we cannot prevent it. I do not think that a
better knowledge of BF can really mitigate, or even
prevent, market excesses. It can explain them with
the benefits of insight. It is like smoking: you know it
is bad for your health, you know you should not
smoke. But you still do it. The same holds true for market behaviour: you know you should be disciplined;
you know you should be rational but you still behave
like a human being.
So the question is: how do we stop it happening
again? First of all, while professionals are also victims
of behavioural biases (because they are also human
beings), they have the advantage of being more disciplined. Secondly, it is important to notice that we are
not talking about only behavioural aspects in finance
but in the economy. We are not only talking about market prices being influenced by psychology; we are also
talking about forces behind economic growth and
cycles, causes for unemployment, recessions or
depressions, cycles in property prices etc and this is
of course a huge impact.
Even though BF provides a convincing explanation
for how traders and investors think before making
decisions, BF has failed to become a mainstream
form of market analysis. Why do you think this is?
The first problem with BF is that, while the topic has
become actively debated among both academics and
practitioners, its lack of mathematical rigour makes its
lessons less recognised. Even if some research shows
that actually sophistication has in some cases the potential to increase investors biases and cognitive errors, a
disciplined approach is the most effective instrument to
try to rationalize investment decisions.
How can BF be used to forecast or anticipate price
movements?
This is the big paradox with behavioural finance. It actually cannot. But it can be used to realise that a theoretically correct portfolio might be not so correct after
behavioural considerations are factored in. Specific risk
characteristics of the client can lead to portfolios that are
Markowitz inefficient, though still appropriate. Or specific goals (which by the way might be based on a bias) can
lead to portfolios that are developed in a not necessarily
pure,
but
still
relatively
rigid,
Markowitz
framework.
16
Apr-Jun 2010
Is it possible to differentiate between intra-day and

longer-term BF effects? If so, how would you do this?
I am not familiar with intraday effects but I think that
most BF effects in my experience are a bit longer-term,
at least a few weeks, in some cases months
What BF experiment do you think is most illustrative
of market behaviour?
Anchoring is an interesting aspect of investing and there
are a few interesting experiments confirming its powerful influence on behaviour. Anchoring is interesting
because it is strictly related to important feelings. When
financial decisions are involved, the situation is different:
you know the outcome of buying stock X instead of
stock Y. If stock X went down and stock Y went up, you
can perfectly calculate not only your loss but also your
missed gain. The pain caused by this kind of regret is
much bigger.
V.H. Medvec and others wrote an interesting article in
the Journal of Personality and Social Psychology back in
1995 about winners of silver and bronze medals at the
Olympic games. It seems that silver winners are less
satisfied than bronze winners because silver is often
perceived as a missed gold, while bronze as a gained
medal (you might have been fourth!). Regret is a very
complex topic. I expect a lot of research in this field in
the near future
Are there any recent developments in BF that you
have found interesting?
One of the most recent bestsellers is Animal Spiritsy:
How human psychology drives the economy, and why it
matters for global capitalism by George Akerlof and
Robert Shiller (Princeton University Press). While I
respectfully disagree with the authors opinion about the
complete lack of control of our animal spirits, going back
to Keyness Animal spirits and revising them and
Technical Trading
tieing them in to the modern literature on BF has great

relevance.
Keep in mind that behavioural finance is still in a very
early stage: learning how people really behave and how
this compares to what we expect them to do is already
difficult enough. Making money out of behavioural
finance, avoiding behavioural mistakes is a different
story. Actually it is not even clear if their mistakes (or at
least some of them) are available at all.
What do you think will be the next advances/ developments in BF?
I think a lot of research will be conducted on the basis of
what has happened and is happening during the crisis.
Not only decision-making and behavioural biases, as well
as biases in probabiliby and belief, but also social biases
need to be readdressed.
Take for example the herd instinct. People adopt the
opinions and follow the behaviour of the majority in
order to feel safer and avoid conflict.
This raises some important unanswered questions:
How important was this behavioural bias during the
post-subprime crisis? In which phases of the crisis does
this kind of behaviour become more acute and dangerous? When do people realize that this behaviour is not
protecting but is actually ruining them because the herd
is going towards the reef?
What areas of behavioural finance are you interested in and do you find most useful?
There are some specific cognitive biases I am particularly interested in. One of them is the confirmation bias; the
tendency to search for information and to interpret it in a
way that confirms our view or simply our preconceptions
(sometimes even misconceptions). In particular, whenever investors buy a stock which starts going down, first of
all they look for information which confirms that their
choice is still OK they only have to stick to it. So they
might fall into post-purchase rationalization, trying to persuade themselves through rational argument, that the
purchase was a good one. If the stock continues to fall,
the next risk is the ostrich effect; ignoring an obvious
negative situation. At some point the stock has lost 30%
and the investor still cannot believe his eyes.
What are the main obstacles in using BF to aid
investment decisions?
We are used to theories with some kind of mathematical
evidence, which BF has not. This makes it more difficult to
systematically use it and in many cases to explain it. After
all, it is a fact that two plus two equals four; but try to
explain to an investor that she should try to avoid the
gambles fallacy (i.e. assume that individual random
events are influenced by previous random events), this is
not intuitively easy to understand.
Apr-Jun 2010
What biases/market behaviour do you most look to

exploit?
Overreaction
Do biases always correct themselves?
Well, yes, but then new biases arise so it is difficult to
say at which point an old bias has corrected and a new
one is created. Basically the problem is that we do not
learn from the past, so biases keep coming back. Our
actual memory of the past changes: it is an adaptive
mechanism. We want to feel good about ourselves, so
we soften the memory of things that would make us
feel bad and more strongly remember those that are
successful. So biases come back and mistakes are
repeated.
Are you aware of any behavioural biases in your
own investing? If so what are they and how do you
deal with them?
We go back to discipline: only a disciplined investment
approach helps reduce biases. Investment policies and
clear lists of clients objective and constraints are the
most useful instruments.
Is herding necessarily a bad or irrational thing to do?
If prices are rising doesnt it make sense to buy as
well? As such, is herding really a bias?
If prices are going up and you buy because everybody else is buying, this is herding and it is a bias
and it is a bad thing to do. If prices are rising and
you buy because you have done your own independent research and come to the conclusion it is worth
buying, this is not herding and it is not a bias and
it is a very good thing to do. Herding has not only to
do with the behaviour but also with the reasons
behind it.
Overconfidence in the markets exists to some extent
because having a pessimistic view is less readily
accepted. Do you think this will change given the
credit crunch and recession?
Well, overconfidence exists also for other reasons. For
example it is related to other biases like the illusion of
superiority. Actually I would say that during this crisis it
has become fashionable to be over-pessimistic (i.e. for
journalists). Have you ever heard of the Von Restorff
effect? It is the tendency for an item that stands out
like a sore thumb to be more likely remembered. So in
todays environment, in which everybody wants to
stand out and be noticed, being over-pessimistic
seems to be more in vogue. But of course, over longer
time periods over-confidence and over-optimism will
prevail again.
17
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The Technical Analyst is published by Global Markets Media.
TNCP
Technical Trading
THE
Triangulation
Indicator: Part 2
By Trevor Neil and Catalin Nicolae Plapcianu
This article follows on from the TNCP Triangulation

Indicator in the last issue. It uses the TNCP Triangulation
Indicator as an entry technique and explains the follow
through technique, the TNCP Adaptor. Together the TNCP
Triangulation Indicator and TNCP Adaptor form a complete
trading system with entry, follow-through and exit. Unusually,
the TNCP Adaptor determines the condition of the market,
trending or non-trending, and reacts to it by adjusting its exit
automatically.
TNCP Adaptor
This turns the TNCP Triangulation signals covered in the last
issue of The Technical Analyst magazine into a system.
Following trade entry with TNCP Triangulation, you can use
the TNCP Adaptor to stay with the trade as long as it has
power and exit at exhaustion. The TNCP Adaptor deterApr-Jun 2010
mines the market condition and the exit set with relation to
the market price and its trading condition. With an entry and
exit technique, we can set rules for trading and create a technique or system.
The market condition

In the last article we detailed TNCP Triangulation. These
identify qualified market pivots. When we have a TNCP
Triangulation pivot we look at the condition of the market. A
TNCP qualified Triangulation pivot takes four bars to form.
After the close of the fourth bar we analyse the market condition to determine how we should follow the trade.
Counter-trending markets
We look back to the 12th bar back from the closing bar (the
fourth bar) of the TNCP Triangulation Pivot. Lets
19
Technical Trading
assume that bar X is the fourth bar of the TNCP

Triangulation Pivot, our entry bar. The last 12 bars are X-12
to X-1.
We calculate the average of the sum of the closes of the last

12 bars to find Y:
(C12+C11++C1)/12=Y
If the close of bar X is above Y we stay long from a TNCP

Triangulation buy Pivot. For the next bar, the fifth bar, the
calculation changes to become more aggressive. We change
the formula from a simple 12-period average to a triangularly weighted 12-period average.
(1*C11+2*C10++12*C0)/1+2++12=Z
(Where Z is the weighted average of the last 12 closes and

C0=4th bar of the pivot.)
This weighted moving average calculation makes the stop follow the price more aggressively. We hold the long position as
long as the close of the bar exceeds the rolling value of Z. We
exit on a closing break of Z.
Counter-trend buying pivot

If a buying pivot occurs (Figure 1), the 4th bar (after the
pivot) had a simple average higher than the last 12 bars and
the 5th bar (after the pivot) had a higher weighted average
than the last 12 bars, then continue the move until the current
close is lower than the weighted average of the last 12 closes
Figure 2.
Trending and counter-trending

Now we define the trending or counter-trending condition.
We do this by looking at the variation of the pips won and
lost. We define Variation as follows:
Variation=sum of pips won and pips lost
Using the following notification: L-pips lost, W-pips won.

Considering the last 12 bars we shall make the calculation:
TL12=total pips lost in the last 12 bars
TW12=total pips won in the last 12 bars
Variation=TL12+TW12=V12, where V12 is the sum of the

pips won and pips lost in the last 12 bars. Now we shall calculate how much TL12 is of V12 and how much TW12 is of
V12 (both in percentages). Neither of them must exceed
10%. If this is so then we are in a counter -trending condition and the PRICE formula above is applied.
Trending markets
We define trending conditions by using the same Variation
measure. First we calculate the variation as before:
Variation=TL12+TW12=V12
Figure 1.
Counter-trend selling pivot

If a selling pivot occurs (Figure 2), the 4th bar (after the
pivot) had a simple average lower than the last 12 bars and
the 5th bar (after the pivot) had a lower weighted average
than the last 12 bars, then continue the move until the current close is higher than the weighted average of the last 12
closes.
20
Apr-Jun 2010
We then calculate how much TL12 and TW12 represent of

V12. Depending on the market move, one will exceed the
other. We look at how it has done so and by how much. If
TL12 exceeds 20% of V12 then the previous move is considered down trending; if TW12 exceeds 20% of V12 then the
previous move is considered up trending. If this is true and
the following conditions are true, we stay in the trade.
A trending buying pivot

a) If the previous move (last 12 bars) was downward and a
buying pivot has occurred and the 4th bar has W (pips won)
greater than the last 12 bars, then continue the trade. This calculation is made until the move is exhausted (Figure 3).
Technical Trading
Figure 3.
b) If the previous move (last 12 bars) was upward and a buying pivot occurred and the 4th bar has W (pips won) greater
than the last 12 bars, then continue the trade. This calculation
is made until the move is exhausted (Figure 4).
Figure 5.
Figure 6.
Figure 4.
A TNCP QUALIFIED TRIANGULATION

PIVOT TAKES FOUR BARS TO FORMWE
[THEN] ANALYSE THE MARKET CONDITION
TO DETERMINE HOW WE SHOULD FOLLOW
THE TRADE.
A trending selling pivot
a) If the previous move (last 12 bars) was downward and a
buying pivot occurred and the 4th bar has L (pips lost)
greater than the last 12 bars, then continue the trade. This calculation is made until the move is exhausted (Figure 5).
b) If the previous move (last 12 bars) was upward and a buying pivot occurred and the 4th bar has L (pips lost) greater
than the last 12 bars, then continue the trade. This calculation
is made until the move is exhausted (Figure 6).
Apr-Jun 2010
A trending selling pivot

Exhaustion comes when W(pips won) are equal to or lower
than one of the last 12 bars in a buying pivot and when L
(pips lost) are equal to or lower than one of the last 12 bars
in a selling pivot. Trending and counter-trending conditions
are not continuous. Therefore at the completion of each bar
the Variation calculation is performed to determine whether
an aggressive or less aggressive stop should be placed.
So we now have a system with entry initiated with a TNCP
Triangulation pivot when the weight of buying switches in a
particular way. This was covered in the last article. Then we follow the trade through using the TNCP Adaptor. This adapts its
exit depending on the market condition, trending or countertrending, depending on pips Variance. A more aggressive stop
is placed when the market is counter-trending than when it is
trending. The position is held until the move has exhausted.
Trevor Neil is the trader and technical analyst at BETA

group and is principal trainer with the Technical Analyst
magazine. Catalin Nicolae Plapcianu is a mathematician and student of technical analysis. Together they
own TNCP Limited. TNCP Triangulation is a trademark TNCP Limited.
21
Market Cycles
and Business
Cycles
Technical Trading
By Brian J. Jacobsen and Wayne Badorf
This article explains the differences and connections between

business cycles and market cycles. We use a ranking technique to
illustrate which asset classes have tended to perform better in different parts of the business cycle.
In this article, we will address tactical allocation: How can you
tilt a portfolio based on the business cycle? Of course, this
begs the question of whether it is even worthwhile to tilt a
portfolio. We believe there is actionable information in economic data that allows asset managers to add value by capitalizing on market inefficiencies or to stabilize a portfolios value.
The goal of conditioning asset allocation on the business cycle
is to capture opportunity on the upside or to protect the portfolio on the downside.
Tilting Based on Business Cycles

Market cycles and business cycles are related, but different.
The business cycle refers to the ups and downs of the overall economy, while market cycles refer to the ups and downs
of the market. Economic fundamentals, like corporate prof22
Apr-Jun 2010
its and interest rates are usually related to stock prices. If the
economy acts in a cyclical manner, then stock prices will also
be cyclical. Assuming market prices, on average, properly
reflect expectations of the economic fundamentals, then
stock market cycles should precede economic cycles (see
Figure 1).
Of course, stock prices can deviate from what a simple dividend discount model would suggest is a fair price for extended periods, a phenomenon that has been called irrational
exuberance or irrational pessimism by various authors. To
label these price deviations as irrational is merely to highlight
how actual prices are out of proportion (rational means in
a ratio to) to the model that the researcher is positing is fair.
If the market price differs from the model price, perhaps it is
the model that is wrong, not the market. Holding on to
Technical Trading
Market
Cycle
Business
Cycle
Figure 1. Relationship Between Business Cycles And Market Cycles
a belief (or a model) that does not estimate what it purports

to represent may be a form of exuberant arrogance on the
part of the model builder, and not necessarily irrational exuberance on the part of the market; after all, there can be
rational herding where individuals use local information to
make decisions. Jeremy Grantham, chief investment strategist of Grantham, Mayo, Van Otterloo & Co., has described
this phenomenon where individuals can behave rationally,
but it results in the crowd looking very unruly.
The stock market is an imperfect predictor of the economy; market participants try to look forward, but forecasts are
not always correct. The bottom of the business cycle tends
to be marked by excess liquidity, low interest rates, and a lot
of fiscal stimulus. Such periods may also feature corporate
restructurings, deleveraging, balance sheet repair, and a
reduction in corporate defaults. Consequently, a cluster of
opportunities might be available at the bottom of the business cycle, which corresponds to an inflection point in the
market cycle.
Conversely, at the peak of a business cycle, interest rates
are higher, and there may be waves of corporate expansion,
mergers and acquisitions, and increased leverage. Typically,
the market peak precedes the business cycle peak as investors
try to anticipate the economic top. As the economy plateaus,
growth expectations are revised downward, creating stockpicking opportunities.
Finally, in the downturn of the business cycle, if there are
monetary and fiscal policy lags, interest rates are too high and
growth expectations are low. The environment is typically
marked by rising corporate defaults, overexpansion, value
destruction, and deleveraging. The key in such an environment is to pick the winners and avoid the losers.
Specific facts about the interest rate environment, credit
conditions, and other economic conditions will tend to favor
different asset classes. Thus, the market cycle dependsto an
extenton the business cycle.
An awareness of the business cycle can thus inform tilts to
a portfolio. Assuming an investor has a normal, or a strategic,
allocation, the question then becomes, When should certain
asset classes be slightly overweighted or underweighted?
To answer this question, we looked at the monthly returns
of various asset classes, along with the monthly changes in
The Conference Boards Coincident Index of Economic
Indicators. For our sector analysis, the data was over the period January 1990 to November 2009. For the broad asset
Apr-Jun 2010
classes, the data went back to January 1979. The Conference

Boards index is designed to give an indication of where the
U.S. economy lands in the business cycle. We then ranked the
monthly changes in the index from the biggest decline to the
largest increase and created six equally sized groups: sharp
decline, mid-decline, mild decline, mild recovery, mid-recovery, and sharp recovery. For each group and each month, we
ranked asset class performance from worst to best and calculated the average asset class rank in that part of the business
cycle. The average ranks were close, but statistically distinct,
which suggests to us that there is some benefit to conditioning asset class exposures to the business cycle.
Tilting Between Active and Passive Management

Because investors demonstrate behavioral biases, such as
extrapolation bias, volatility (dispersion) tends to pick up at
the inflection points and turning points of the economy. At
turning points of the economy or points of inflection, using
the recent past to make a linear extrapolation into the near
future tends to generate more errors on the part of forecasters and creates alpha-driven markets. Outside of inflection
points, markets tend to be more driven by broad market factors. This is what can be considered a beta-driven market.
To illustrate these shifts from alpha to beta markets, we
looked at changes in the slope of the yield curve (a graphical
representation of the relationship between the yield on a
bond and the maturity of the bond). Over short horizons
(using daily data), changes in the slope of the yield curve are
primarily driven by news and not long-term trends. Thus, an
observed change in the slope of the yield curve (measured by
the spread between the 10-year Treasury note yield and the 2year Treasury note yield) should indicate news flow. Since we
are interested in news flow and not characterizing whether
that news is good or bad, we related the square of the daily
change of the slope of the yield curve to daily changes in the
VIX (the volatility index for the S&P 500 Index) from
January 2, 1986, to January 18, 2010. We observed a strong
statistical relationship between changes in the VIX and
squared changes in the yield curve (R-squared is equal to
97.4% and the coefficient is positive, as expected).
This suggests that news flow creates volatility, and volatility indicates changes from beta-driven to alpha-driven markets. This news flow tends to cluster around turning points
and inflection points of the business cycle. This suggests that
active managerswho are supposed to deliver alpha
23
Economic Activity
Technical Trading
Asset Classes
Recovery
Decline
Bonds vs. Stocks
Stocks
Stocks
Stocks
Stocks
Stocks
Stocks
Bonds
Bonds
Bonds
Stocks
Large vs. Mid vs.

Small
Small
Large
Mid
Large
Small
Large
Mid
Mid
Mid
Large
Value vs. Growth
Value
Value
Value
Value
Value
Value
Growth
Growth
Growth
Value
Active
Active
Passive
Active
Active
Active
Active
Active
Active
Active
Telecomm.
Info. Tech.
Financials
Info. Tech.
Telecomm.
Energy
Energy
Health Care
Energy
Energy
Utilities
Health Care
Telecomm.
Health Care
Utilities
Materials
Industrials
Consumer
Stap.
Industrials
Materials
Second Worst
Sector
Consumer
Discr.
Energy
Health Care
Energy
Consumer
Discr.
Health Care
Telecomm.
Telecomm.
Telecomm.
Health Care
Worst Sector
Health Care
Materials
Industrials
Materials
Health Care
Telecomm.
Financials
Utilities
Financials
Telecomm.
Management Style
Active vs. Passive
Sectors
Best Sector
Second Best Sector
Figure 2. Historical Relationship between the Business Cycle and Asset Class Performance
should be used at those turning points and inflection points

of the business cycle.
Tilting in Your Practice

One of the challenges that investors face is identifying where
exactly the economy lands in the business cycle.
Unfortunately, the U.S. economy does not come equipped
with a global positioning system. Economic data released by
the government and other agencies are backward-looking.
The questions are always, Where are we, and where are we
headed?
Figure 2 shows a typical business cycle, as measured by
changes in general economic activity. Immediately below the
business cycle graph is a table that indicates how the different asset classes, management styles, and sectors performed
during that particular part of the business cycle. To use the
chart, pick a point on the business cycle graph and look
immediately below that point to the table to see what area has
historically performed the best during that period.
24
Apr-Jun 2010
Conclusion
The markets and the economy are tied together: business
profitability varies across the business cycle and investors typically anticipate these changes in profitability. Because of
behavioural biases, market prices can systematically over- and
undershoot what the fundamentals would dictate. In this article we have examined these historical tendencies to show
what, historically, outperforms in various parts of the business cycle. This analysis can hopefully help in making portfolio allocation decisions as investors search for investment
opportunities in all parts of the business cycle.
Brian J. Jacobsen (Ph.D., CFA, CFP) is Chief Portfolio
Strategist and Wayne Badorf (CFP) is National Sales
Manager at Wells Fargo Funds Management, LLC.
The views expressed are of March 31, 2010, and are those of Dr. Brian Jacobsen and Wayne
Badorf, and not those of Wells Fargo Funds Management, LLC. The views are subject to
change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector
or the markets generally, or any Wells Fargo Advantage Fund.
Awards
Celebrating Excellence in Technical Analysis and Automated Trading
Apr-Jun 2010
25
Awards
The Technical Analyst was proud to present its 2010 awards at our annual awards ceremony held at the
Sheraton Park Lane Hotel on 25 March 2010. We would like to congratulate the winners and finalists and
thank all those who took part in this years event, including over 100 nominees, and most especially our panel
of judges who found time amongst their regular work schedules to appraise the nominations.
We would also like to thank our guest speaker, Robin Griffiths, for giving the audience a fascinating and
highly entertaining after dinner speech. With his huge experience in the markets, Robin is without doubt the
leading figure in the technical analysis community and his help and support to the magazine over the years
has been invaluable.
Research & Strategy Awards

Best Equity
Judges:
Charles Morris
(HSBC Global Asset Management)
Avi Hooper (Invesco)
Shortlised Finalists:
DayByDay
Dorsey, Wright and Associates
Friedman Billings & Ramsey Int.
Lowry Research Corporation
Redburn Partners
Winner:
Lowry Research Corporation
Like last year, the judges were impressed with the outstanding breadth and innovation of Lowry Research
Corporations output. Valerie Gastaldy's work at DayByDay was also highly praised.
Best FX
Judges:
Jessica James (Citigroup)
Chris Charlton
(Centa Asset Management)
Shortlisted Finalists:
Informa Global Markets
PIA
RBC Capital Markets
Royal Bank of Scotland
TRADING Central
UBS Investment Bank
Winner:
RBC Capital Markets
In this category the judges decided to assess the finalists by looking at several key areas: pure technicals;
strategy; personal committment & integrity (i.e. follow-up of previous strategy recommendations and profit &
loss acknowledgement); brevity and presentation.
They were particularly impressed with PIA who they thought, Offered the best technical trading service for
short-term traders with very good personal integrity - an excellent service. Informa Global Markets was also
praised as a good service for general strategy and for keeping abreast of the markets. The winner, however,
was RBC Capital Markets for its, Solid all round offering with innovative strategies, particularly in hedging,
providing an excellent service for a wide audience.
26
Apr-Jun 2010
Awards
Charles Morris (left) of HSBC Global Asset Management collects the award for Best Equity Research &
Strategy on behalf of Lowry Research Corporation from compere Gerald Ashley.
George Davis (right), Director and Chief Technical Analyst, Fixed Income and Currency Strategy at RBC Capital
Markets, collects the award for Best FX Research & Strategy from Chris Charlton of Centa Asset Management.
Apr-Jun 2010
27
Awards
Clive Lambert (left), Director of FuturesTechs, collects the award for Best Fixed Income Research & Strategy
from Avi Hooper of Invesco.
Paul Day (left), Chief Market Analyst at MIG Investments, collects the award for Best Specialist Research from
Alex Spiroglou of ODIN Capital Management.
28
Apr-Jun 2010
Awards
Best Fixed Income

Judges:
Charles Morris
(HSBC Global Asset Management)
Avi Hooper (Invesco)
FuturesTechs
Informa Global Markets
PIA
Royal Bank of Scotland
UBS Investment Bank
Winner:
FuturesTechs
The category for Fixed Income Research & Strategy was particularly close, with each of the finalists having
something valuable to offer. In the final analysis, the award was given to FuturesTechs for the high quality of
their overall research process and clear presentation style.
Best Specialist Research

Judges:
Trevor Neil (Betagroup)
Alex Spiroglou
(ODIN Capital Management)
Dorsey, Wright and Associates
eYield
Financial Trend Analysis
JPMorgan Equity Quant Research
MIG Investments
Winner:
MIG Investments
This category by its nature covers a variety of companies offering many different services or research specialities; from eYields Elliott Wave based market commentary to last years winner, JPMorgans Equity
Quant Research team, who produce excellent research that is highly relevant to technical analysis and
momentum trading in particular. However, for their, "Well explained, usable, practical, specialist technical
research based on DeMark's indicators", the judges declared Paul Day of MIG Investments the winner.
Apr-Jun 2010
29
Awards
Product Awards
Best Specialist Product
Judges:
Alex Spiroglou
(ODIN Capital Management)
Fidessa (FFI and Fragulator)
ITTrading
(Candlestick Pattern Tracker)
Market Studies
(DeMark Indicators, Cursor
Commentary and TD Research)
Recognia
TraderDNA
Winner:
Recognia
The finalists for the Best Specialist Product category were once again an interesting mix of products and
companies, including Fidessas Fragmentation Index and Fragulator which provides a measure of how different stocks are fragmenting across primary markets and alternative venues. In the final analysis, and
based on the strength of the nomination, Recognia was declared the winner for their, "Clever powerful pattern recognition software."
Best Data Provider

Judges:
Matthew Clements
(The Technical Analyst)
Bloomberg
CQG
Interactive Data
QuantHouse
TraderMade
Winner:
Bloomberg
Whilst TraderMade provides excellent data for the FX markets and QuantHouses QuantFeed provides a
first class ultra-low latency solution for automated and algorithmic trading, the judges gave the award to
Bloomberg for, Their outstanding and comprehensive market data offering across all asset classes.
Best Automated Trading Product

Judges:
Ernest Chan
(E. P. Chan & Associates)
Paul Netherwood (Beach Horizon)
Alphacet
FlexTrade Systems
Patsystems
Progress Apama
QuantHouse
TickCOM
Winner:
Progress Apama
The judges took a highly systematic approach to this category, scoring finalists based on 15 key criteria. In
the end, three nominees - Alphacet, Progress Apama and QuantHouse - scored incredibly closely and all of
them would have been worthy winners.
Progress Apama were awarded the category for the second year running with their excellent all-round
easy-to-use product scoring solidly across the board, and particularly well in the area of execution integration.
QuantHouse ran Progress an incredibly close second. The judges thought it especially good with regard to
historical data coverage and programming ease of use. Flextrade also did well in the more specific area of
algorithmic execution, scoring top marks for Execution Algorithmic Development.
30
Apr-Jun 2010
Awards
Eugene Sorenson (right), TA Specialist at Bloomberg, collects the award for Best Data Provider from Trevor
Neil of Betagroup.
Guest speaker Robin Griffiths of Cazenove Capital Management

Apr-Jun 2010
31
Awards
Jeremy du Plessis (left) and David Linton (right) of Updata collect the award for Best Technical Analysis
Platform from Rashpal Sohan of Rathbones.
George Davis (right) of RBC Capital Markets collects the award for Technical Analyst of the Year from
Trevor Neil of Betagroup.
32
Apr-Jun 2010
Awards
Best Technical Analysis Platform

Judges:
Rob Brand (ABN AMRO)
Rashpal Sohan (Rathbones)
Bloomberg
CQG
TraderMade
tradesignal
Updata
Winner:
Updata
The judges tried to be as objective as possible, comparing the platforms across some 164 different factors.
They recognised that some aspects cannot be easily quantified such as look and feel, adaptability of the
system, level of support etc, but they tried as much as possible to incorporate all of these factors into their
final decision.
Updata has succeeded in incorporating a vast number of analyses into their platform. The number of
methodologies is rapidly increasing and is in our view constantly adapting to clients wishes; this is one of
Updatas key strengths. The look and feel of the platform is second to none and the ability to link to several
external data providers is a plus. Key strengths are the charting engine (especially point&figure), multiportfolio backtesting abilities, programming in easy to use language, reporting capabilities and catering for
users from all walks of life. Updata releases new updates fairly regularly responding to new demand from
clients, and new insights or improvements to the system.
The judges were also impressed with CQG and Bloomberg: CQG has been a leading product for more
than 30 years, making them the industry standard. We liked the availability of clean data and the vast number of proprietary third party analyses (such as DeMark methodologies) on the platform. Easy to use and
powerful analysis capabilities are CQGs key strengths.
The technical analysis capabilities of the Bloomberg system, on the other hand, have improved fantastically in the last few years. Incorporating programming capabilities is a factor to work on however. No doubt,
Bloomberg is one of the most comprehensive and easy to use platforms while maintaining high quality and
standards in both look and feel and methodologies. The link to other non-technical information such as
security pricing and news is invaluable.
Technical Analyst of the Year

Judges:
Matthew Clements
(The Technical Analyst)
Shortlisted Finalists
Dave Floyd
(Aspen Trading Group)
Jean-Charles Gand (Socit
Gnrale Gestion (Amundi Group)
Valrie Gastaldy (DayByDay)
Thomas Schroeder
(Chart Partners Group)
Plus the winner from each
Research & Strategy category
Winner:
George Davis,
RBC Capital Markets
For his well presented, innovative research and strategy in the FX markets, George Davis also won
Technical Analyst of the Year. Honourable mention however must also go to Valrie Gastaldy at DayByDay
and Jean-Charles Gand at Socit Gnrale Gestion (Amundi Group).
Apr-Jun 2010
33
Interview
INTERVIEW
Leon Diamond started his career as an

analyst at EL&C Baillieu Stockbroking in
Australia where his role involved generating trading ideas based on technical
research into Australian equities and equity derivatives. He later worked at Folkes
Asset Management in London where he
was responsible for overseeing the development of a hedge overlay for mutual
funds using global futures markets.
Leon joined Castlestone Management
in January 2006 as portfolio manager to
the firms Porcupine Global Macro Plus
fund which focuses on investment in the
major asset classes plus the commodity
and agricultural markets. He talks to the
Technical Analyst about how he looks to
exploit mispricing in todays markets.
Apr-Jun 2010
35
Interview
36
Apr-Jun 2010
Interview
TA: What are the main markets you trade? Can you give
a brief description of your main funds, AUM and investment approaches?
TA: How would you describe your approach to asset

allocation? What factors do you look for in coming to a
decision?
LD: Our trading approach is 100% discretionary, using fundamental analysis to develop trading themes and overlaying
technical analysis for trade implementation. We take directional and relative value positions using futures and forwards
in the G10 markets within four major asset classes: equities,
fixed Income, commodities and FX. The main fund is the
Porcupine Global Macro Fund and our objective is to generate positive absolute returns while managing downside
volatility. Assets under management total $33m as of 31st of
March 2010.
LD: We start with a target risk/return profile. Our target

return is 14% to 16% net of fees with a volatility of 10%; an
absolute return strategy with a target of capital preservation.
With this in mind we take into consideration downside risk.
This is the starting point. From there we take into account
correlations over multiple time horizons ranging from 30
days, looking at intra-day price action all the way to 30yr time
periods. Additionally we look at different market cycle correlations and market dislocations such as the tech bubble burst,
Russian bond crisis, credit crisis just to name a few.
LD: On average, our fund enjoys a monthly return of 3.27%

since inception and saw an annual return in 2008 and 2009 of
14.43% and 7.12% respectively. The credit crisis produced a
loss period for us that ran from September to October
2008 when the fund was down 3.15%. During that time we
were short the VIX and long the S&P500 and these
positions were cut during the first week of October. Risk was
also reduced by adopting more disciplined stop-loss
measures. In all, it took about three months to recover
from this.
LD: We track market correlations and review them constantly. Relationships tend to be highly correlated for periods then
often become crowded, or are affected by fundamental news
flows, and then the relationship becomes non-correlated. For
example, in 2007 we were long corn, short wheat and dollar
neutral. Part of the trade thesis was a play on crop rotation
and price equilibrium. The other part of the trade was a play
on ethanol. The correlation between long corn/short wheat
at the time was 0.86.
TA: How did your fund performe in 2008-2009 and

why?
TA: What type of analysis do you employ on a

daily/weekly basis?
LD: Our investment philosophy is based on the view that in

the short and medium-term, structural inefficiencies or mispricings occur in the global markets. Markets tend to become
mispriced in response to liquidity cycles, business cycles, economic data releases, geopolitical events and human nature.
We identify the mispricing in the market and seek instruments
that best represent our view providing strong risk / reward
opportunities. We then have a trading discipline focusing on
capital preservation; price targets and stop losses which are
set with every trade on entry.
TA: How do you indentify when prices are inefficient?
LD: Identifying price inefficiencies are derived from our rigorous research process. We believe that the market becomes
mispriced for a number of reasons: this includes, behavioural finance and how the markets react to the release of estimated data, and the concept of reflexivity (as discussed by
George Soros) which states that at some point in time
markets will return to their fair value or the
unexplainable price action will disappear which creates a trading opportunity.
Apr-Jun 2010
TA: With the commodities markets, are there any useful

cross market correlations that can be used to anticipate
market moves?
TA: To what extent are the commodities markets speculative in nature and to what extent are they driven by
fundamental factors?
LD: The best way to describe fundamental factors vs speculation is to take a view on your investment horizon. The longterm is the great fundamental play in the commodity market.
Shorter-term price action is driven by speculation. An example is gold. Gold has rallied from approximately USD$340 to
USD$1150 over six years. This longer-term move has been
due to several fundamental factors such as the USD depreciation against emerging market currencies, inflation hedging,
geopolitical hedging, real asset plays and a credit crisis
hedge. However, as we have seen over the last 12 months, as
more participants are able to trade gold (in the form of
Exchange Traded Commodities and Funds), gold price
moves can be seen as speculative in the short-term with the
longer-term trend still rising.
TA: Are there any trading/investment strategies unique
to the commodities markets that you tend to employ?
LD: We look at calendar spreads and at backwardation as a

carry trade. Due to the introduction of ETCs/ETFs in the
market place and the money that is flowing into indexes (typically indexes buy the front month), the front month con-
37
Interview
IF SHORT-TERM TRADING
OPPORTUNITIES ARE SEEN, WE WILL LOOK FOR
EXHAUSTION OR BREAKOUT MOMENTUM PLAYS.
tract can become crowded. Structuring calendar spread trades
can be advantageous during these times.
TA: What are the main advantages to trading the agriculturals? Are there any seasonal factors that are relatively easy to exploit?
LD: We do take into account seasonal effects. An example is

the planting season and weather conditions associated with it.
We have found the United States Department of Agriculture
(USDA) published estimates of crop planting to be quite unreliable and because the sample size is so small, they are often
subject to large revisions. More importantly, they provide only
a limited guide to actual crop yields which is more important to
prices. We look to take advantage of this in the market place.
We usually look at the wheat, corn and soya markets and in
these markets, much of the speculative element we have seen
in them in recent years has now disappeared. The market
seems to have realised that the agriculturals, and other commodity markets, were massively overbought and so the wide-
38
Apr-Jun 2010
spread speculative fad for these seems to be over.
TA: To what extent do you employ technical analysis in

your short-term position taking?
LD: With short-term positions, technical analysis forms a

large part of the investment process. If short-term trading
opportunities are seen, we will look for exhaustion (turning
points in the market) or breakout momentum plays.
TA: How do you identifying price exhaustion in markets?
LD: We typically look at exhaustion price action in the markets. This can be identified in a number of ways: trading volume levels tend to stabilise or start declining, fatigue in the
price action by rate of change and open close tick data, additionally the market begins to tire of fundamental reasons for
buying or selling and the media becomes overly obsessed
with a particular market.
Interview
TA: Do you actively measure momentum in the markets

you trade, and if so, how?
LD: Yes, typically we are looking at price action in the

market. For this we use volume data, moving averages,
Elliott Wave theory and the RSI (relative strength indicators). Our preferred volume data is exchange futures
and options figures. For us Elliott Wave theory fits
with our global macro approach, helping us identify
where we are in price trends. The theory allows us to
identify bouts of optimism and pessimism. As such, it
does have some ability to measure the degree of speculative buying pressure in the market and not just that
which is based on fundamental news. We also use RSI
(relative strength indicators) to identifying trade patterns of over-buying and/or over-selling.
TA: How do you decide when to trade a particular market? For example, in the commodities or agricultural,
how do you identify when to buy a particular market
such as soy beans, copper etc?
LD: We start with fundamental information. The team internally generates ideas using top down and bottom up analysis.
Once we have our view, we then assess the best way to implement the trade. Timing of the trade, using technical analysis
allows us to help leg into the trade, as well as sizing of the
trade. In structuring the trade, we typically use a directional
strategy using futures, with stop-losses and options to preserve capital on the down side.
TA: Can you expand on your approach to risk management, for example on your use of stop-losses?
OVER THE NEXT TWO

YEARS WE BELIEVE
THAT WE ARE GOING
TO SEE RANGEBOUND
MARKETS FOR
EQUITIESTHE
RETURN WE HAVE
SEEN OVER THE PAST
10 YEARS OF
0-2% WONT GET ANY
BETTER.
LD: To establish an entry price into a trade, we use what

we called entry bands. These are based on a fundamentally-based price. We then establish multiple time period
price targets and stop-losses. This means that we might
place a stop based on where we think prices are achievable over the short-term. We will then lock in this price
move with a stop and then look to where we think prices
will ultimately go. This means we can achieve our longerterm price target but can also protect short-term price
moves that are in our favour. We will exit the trade either
when our fundamental views change due to new data
points or when the risk/reward structure is no longer
attractive. We find the best risk measure is having a hard
stop on every position and at the portfolio level. Each
position that is entered has a set notional amount of
money it will lose, based on volatility, overall portfolio
construction, correlation, and risk reward opportunities.
The fund usually sits with a hard stop per month of 8%.
When we perceive a higher level of correlation risk then
we will lower our exposure in a particular market and
visa versa.
Apr-Jun 2010
39
Interview
TA: What markets are likely to offer the best investment

opportunities over the next two to three years and why?
LD: I think agriculture commodities, corn, soybeans and

wheat offer the best two to three year outlook. Grain prices
have been sold off in the last 12 months due to a record harvest and near perfect crop planting conditions. Consequently,
current prices of the grains are at unsuitably low levels and
need to rise. Not only have input costs risen, but demand
from developed markets continues to grow.
Trading discipline will set apart macro hedge funds. Over
the next two years we believe that we are going to see rangebound markets for both equities and commodities. This
doesnt mean that market prices wont fluctuate, but rather
that the annualised return we have seen in equities over the
past 10 years or so of 0-2% wont get any better for the time
being. This is because there is no obvious reason for a structural shift in the value of equities on the horizon. Whilst 2010
will be a strong year for equities, we are not so confident
going into 2011. On the other hand, as pressure is applied to
China to raise the Yuan leading to a gradual devaluation
against developed currencies, we see that commodity prices
will be underpinned.
The trading desk at Castlestone Management in London
40
Apr-Jun 2010
DISCLAIMER
This document is intended only for professional investors and financial advisers.
The material on these pages is provided for information purposes only; it is not
an invitation to invest. Income from investments may fluctuate and investors
may not recoup the amount originally invested. Please refer to the relevant funds
Confidential Explanatory Memorandum for detailed information and/or seek
relevant professional advice before making any investment decision. This document contains forward-looking statements concerning the financial condition,
results of operations and businesses of Castlestone Management. Such statements, expressed or implied, are based on management's current expectations
and assumptions, which may change without notice, and are no guaranteemof
future results, performance or events. This document does not constitute an
offer or solicitation to sell shares in any of the funds mentioned, by anyone in
any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it is unlawful to make such offer or solicitation. Persons interested
in acquiring funds should inform themselves as to (i) the legal requirements in
the countries of their nationality, residence, ordinary residence or domicile; (ii)
any foreign exchange controls; and (iii) any relevant tax consequences. Selected
retail fund share classes may include an administration fee, which is not paid to
the Investment Manager.
Castlestone Management Limited is authorised and regulated by the Financial
Services Authority in the UK. Securities and Exchange Commission. Castlestone
Management Limited is authorised by the Financial Services Board in South
Africa. Castlestone Management Inc. is regulated by the British Virgin Islands
Financial Services Commission.
*The data denotes the actual performance net of management fees, performance fees and expenses of the Porcupine Global Macro Plus share class C. Past performance is not a guide to future
returns.
Research Update
ASSYMETRIC
BIASES
A number of behavioural finance theories posit that investors

adhere to prior beliefs in spite of new information. A paper from
Jeremy Ko of the Securities and Exchange Commission and
James Huang of the University of Wisconsin reports the results
of an experiment which shows that an investors inferences are
biased by their prior beliefs in a manner that depends on investment outcomes. Specifically, their perception of new information was more positively biased for their prior favoured assets
when incurring losses than gains. This asymmetric bias may help
explain empirical patterns such as loser momentum and suggests
modifications to models of belief persistence in markets.
Ko, K. Jeremy Jeremy and Huang, Zhijian (James), Persistence of Beliefs

in an Investment Experiment (February 15, 2010).
STOCK RETURNS AND

SHORT INTEREST
What happens to stocks that experience relatively high or low

short interest? A US-based team of researchers have found that
stocks with relatively high short interest subsequently experience negative abnormal returns, but the effect can be transient
and of debatable economic significance. In contrast, they found
that relatively heavily traded stocks with low short interest experience both statistically and economically significant positive
abnormal returns. These positive returns are often larger than
the negative returns observed for heavily shorted stocks. Thus,
the positive information associated with low short interest,
which is publicly available, is only slowly incorporated into
prices.
The good news in short interest, Boehmer, Ekkehart; Zsuzsa, R.;

Jordan, Bradford D. Journal of Financial Economics, Volume 96, Issue
1, Feb 2010, 80-97.
Does an Admired Company Equal Admirable Returns
Do stocks of admired companies yield

admirable returns? Are increases in admiration followed by high stock returns?
And how reliable is the relation between
admiration and returns? These are the
questions that two US researchers
answer. They study Fortune magazines
annual list of Americas Most Admired
Companies and find that stocks of

admired companies had lower returns, on
average, than stocks of spurned companies from April 1983 through December
2007. Moreover, they find that increases
in admiration were followed, on average,
by lower returns. They also find that the
dispersion of returns is high, especially in
All papers are available from the Social

Science Research Network, SSRN,
www.ssrn.com
INDIVIDUALISM AND
MOMENTUM PROFITS
A team of international researchers has examined how cultural differences influence the returns of momentum strategies.
They measure cross-country cultural differences using an individualism index developed by Hofstede (2001), which is related to overconfidence and self-attribution bias. The authors
find that individualism is positively associated with trading volume and volatility, as well as to the magnitude of momentum
profits.
Individualism and Momentum around the World, Andy C. W. Chui,
Sheridan Titman, K. C. John Wei, Journal of Finance, Volume 65,
Issue 1, Feb 2010.
Apr-Jun 2010
the spurned portfolio. This implies that

investors who want to benefit from the
return advantage of spurned stocks must
diversify widely among them.
Statman, Meir and Anginer, Deniz, Stocks of
Admired Companies and Spurned Ones
(January 22, 2010).
OPTIONS VS
FREQUENT TRADING
A growing literature suggests that even in the absence of any

ability to predict returns, holding options positions on the
benchmark assets or trading frequently can significantly enhance
performance ratios. A paper from a US team of researchers
derives a performance maximizing strategy - a variant of buywrite - showing that if common equity indexes are used as
benchmarks, the potential performance enhancement from trading frequently is usually negligible. In contrast, the enhancement
from holding options can be substantial if the implied volatilities
of the options are higher than the volatilities of the benchmark
returns.
Guasoni, Paolo, Huberman, Gur and Wang, Zhenyu, Performance
Maximization of Actively Managed Funds (February 2010). CEPR
Discussion Paper No. DP7676.
41
Research Update
DISPOSITION EFFECT
AND FUND FLOWS
Are the behavioral biases of fund
managers affected by capital flows?
Two researchers at the National Cheng
Kung University have examined the
relationship between fund flows and
the disposition behavior of fund managers. They find that the disposition
biases of fund managers are significantly negatively correlated with unexpected fund flows, but insignificantly
correlated with expected fund flows.

Further evidence shows that fund performance is influenced more by the
flow-induced rather than the nonflow-induced disposition behavior of
fund managers.
Chiang, Min-Hsieng and Huang, Hsin-Yi, Do
Mutual Fund Flows Drive the Disposition Behavior
of Fund Managers? (March 15, 2010).
OWNERSHIP CONCENTRATION
AND EARNINGS ANNOUNCEMENTS
A team from INSEAD have studied the behaviour of stocks with concentrated institutional ownership. They show that following earnings announcements concentrated
stocks exhibit superior abnormal returns. This effect is equally strong for positive and
negative surprises. A trading strategy long in announcing stocks from the highest concentration quartile and short in announcing stocks from the lowest concentration quartile delivers an average monthly return of 1.32%. This return fades rapidly if the portfolio is held beyond the month of the announcement. The profits from the trading
strategy are largely unaffected by direct or indirect transaction costs for reasonably large
portfolio sizes.
The authors suggest that closely held stocks might benefit from strategic trading by
holding institutions which have incentives to keep stock prices and portfolio values
high. In line with this theory, they find that institutions significantly reduce their selling
pressure in concentrated stocks around earnings announcement thereby withholding
liquidity and forcing price inflation. The concentration effect is stronger if the stock is
held by funds representing few families, underperforming funds, and funds for which
the stock is a major investment.
THE PREDICTIVE
VALUE OF
INSTITUTIONAL
OWNERSHIP
Wenlan Qian of the National University

of Singapore has shown that the positive relationship between institutional
ownership and subsequent returns documented in the literature is driven by the
negative abnormal subsequent returns
associated with low institutional ownership stocks. In contrast, high institutional ownership is unrelated to future
returns. Furthermore, institutional trading is only informative in the low institutional ownership stocks. These findings
have the key implication that institutional ownership as an indicator of pricing
efficiency plays an important role in
explaining its predictive power on future
returns. As a result, the previous weak
evidence regarding the informativeness
of institutional trading is likely due to
low power in studying the average trading effect. Using an empirical strategy
that maximizes identification, he also
finds that institutional trading predicts
returns because of institutions' ability to
identify overvalued stocks and sell them
prior to price decline. In addition,
"smart trading" has the strongest impact
on future returns among stocks with
both low institutional ownership and
high information uncertainty.
JQian, Wenlan, An Anatomy of the

Information Content of Institutional Ownership
(March 24, 2010).
Forecasting Extreme Performers
Chuprinin, Oleg, Massa, Massimo and Loutfi, Zeina, Too Few Investors Make the Party: Analysis of
Return Patterns in Stocks with Concentrated Ownership (March 15, 2010).
Based on State Street Global Advisors

previous research on predicting extreme
stock performers in the US equity market, Ying Becker of SSgA and Richard
Ochman of Adair Capital extend the
study to the European equity markets.
They investigate important characteristics
of stocks in the MSCI Europe index pre42
dicted to experience extreme returns over

the next three-months. With a two-stage
multivariate logistic model, they separate
extra performers into winners and losers.
For the entire test period, over 17 percent
of 60 predicted extreme performers
experienced extreme price movements in
the subsequent three-month period. They
Apr-Jun 2010
attain an average total three-month return

of 4.5% by going long (short) predicted
extreme winners (losers) over the period
of September 1994 to June 2001.
Becker, Ying L. and Ochman, Richard,
Predicting Extreme Performers in European
Equities (April 7, 2010).
Research Update
Identifying Crowded Trades
The financial crisis of 2008 highlights the

importance of detecting crowded trades
due to the risks they pose to the stability
of the financial system and to the global
economy. However, there is a perception
that crowded trades are difficult to identify. To date, no single measure to capture
the crowdedness of a trade or a trading
style has developed. To answer this,
Richard Levich of New York University
and Momtchil Pojarliev have proposed a
methodology to measure crowded trades
and apply it to professional currency
managers. Their results suggest that carry

became a crowded trading strategy
towards the end of Q1 2008, shortly
before a massive liquidation of carry
trades. The timing suggests a possible
adverse relationship between their measure of style crowdedness and the future
performance of the trading style.
Crowdedness in the trend following and
value strategies confirm this hypothesis.
The authors apply their approach to currencies but the methodology is general
and could be used to measure the popu-
A COMBINED FUNDAMENTAL AND

TECHNICAL MOMENTUM STRATEGY
Can a technical momentum strategy be improved upon through the inclusion of fundamental information? This is the question posed by a research team from Rutgers
University who examine how fundamental accounting information along with the
technical information such as past returns and past trading volume data can be used
by investors to separate momentum winners from losers. Previous research has shown
that the technical momentum strategy based on the past winners and losers in terms
of cumulative returns, generates significantly positive returns in the subsequent periods. This new paper proposes a unified framework of incorporating the fundamental
indicators FSCORE (Piotroski (2000)) and GSCORE (Mohanram (2005)) into the
technical momentum strategy. The authors have developed three hypotheses to test
whether a combined momentum strategy outperform the technical momentum strategy or not. From the empirical results of these three hypotheses, the authors conclude
that the combined momentum strategy outperforms a technical momentum strategy
by generating significantly larger returns for both growth and value stocks.
Lee, Cheng-Few and Shih, Wei-Kang, Technical, Fundamental, and Combined Information for
Separating Winners from Losers (April 15, 2010).
THE DIMINISHING INDEX EFFECT
larity or crowdedness of any trade with

an identifiable time series return.
According to Levich and Pojarliev, their
methodology may offer useful insights
regarding the popularity of certain trades
in currencies, gold, or other assets
among hedge funds.
Levich, Richard M. and Pojarliev, Momtchil T.,

Detecting Crowded Trades in Currency Funds
(January 2010). NYU Working Paper No.
FIN-09-037.
All papers are available

from the Social Science
Research Network, SSRN,
www.ssrn.com
The index effect, or the excess returns of a stock added to a leading index, is one of the most researched pricing anomalies in
finance, but is the index effect shrinking? To answer this question, Standard & Poor's Index and Portfolio Services studied the index
effect for headline indices of five of the biggest equity markets in the world: U.S. (S&P 500), Canada (S&P/TSX 60), Japan (Nikkei
225), U.K. (FTSE 100) and the Germany (DAX 30). They found that excess returns for index additions have diminished over the
past five years. The median excess return of S&P 500 additions was 3.8% for the past five years, compared to 6.0% for the five years
prior. The declining pattern is also observed in Nikkei 225, S&P/TSX 60 and DAX 30, but not the FTSE 100.
The authors attribute the diminishing index effects to several possible factors: 1) The index effect has fallen victim to its own popularity. As more arbitrageurs have come in to the market, arbitrage profits have reduced and 2) Changes in market structure and trading patterns of index funds have dented the index effect. They conclude that the index effect may never vanish completely, but its
days as a profitable trading strategy may be numbered. Alternative index related profit opportunities may involve trading index
changes in the options market or trading index share changes.
Standard & Poor's, Index and Portfolio Services, , The Shrinking Index Effect: A Global Perspective (November 1, 2008).
Apr-Jun 2010
43
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