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We speak to Jason Perl, head of technical
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indicators in his client research
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October 2008 THE TECHNICAL ANALYST 1
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4 YEARS IN A ROW
W 2005-2008 6 YEARS IN A ROW 2003-2008 MARCH 2008
16 47
ISSN(1742-8718)
FTSE 100:
major low
at 3277
By Sandy Jadeja
Sandy Jadeja
4 THE TECHNICAL ANALYST October 2008
Market Views
The financial markets have been hit by a tornado of selling which has taken
major indices to new five year lows. The question on investors and traders
minds is how bad can this really get?
Support levels bar before attempting to buy a particular stock. Many have
The UK FTSE 100 index has already lost 37% from the July tried to capture bargains in the financial stocks only to have
2007 high of 6754. A bear market is considered if a decline found that the pain of losing can be excruciating as it has
of 20% or more is in place. Clearly we have surpassed this been in this particular sector.
and sentiment figures are showing that we are already in a If we take seasonality and cycles into consideration, the
bear market. One should remember that the rally we saw year 2007 was already flagged as being a potential high. We
from March 2003 reached a high of +106% and so the know that years ending with sevens tend to be marked by
decline can be counted as a retracement, albeit a major one. market highs and years ending with twos offer market lows.
Unless we surpass 3277 on the FTSE - which equates to the This suggests that we are likely to be in a bear market until
neckline of a double top formation (see Figure 1) - the cur- 2012, with a strong corrective rally during 2009. The major
rent move is still classified as a correction. indices had also reach Fibonacci Price Extensions and Elliott
Wave traders had seen a major five wave pattern pointing to
a market fall.
Turning points
In the current market if one were to use oscillators and lag-
ging indicators, such as moving averages, one would find that
these tools would be rendered useless. The market has tech-
nically been oversold for three months now and oscillators
tend to perform poorly in trending markets. For short term
forecasts a break above the weekly high is far more superior
for the bulls and vice versa for the bears. Price tools have
Figure 1 always been more powerful than indicators which are simply
derivatives of price anyway.
Technically the key support levels are 4605 and 4020 of Analysing open interest figures has shown that there have
which the latter should hold the index up. If we fail to stay clearly been more sellers than buyers recently and volume on
above 4020 this would have serious implications for the the downside has been three times greater than the upside on
index as the next support level would be below the major low average. This is typical in downtrends once panic kicks in. We
coming in at 3277. Although this sounds unrealistic we still do not have a full out bearish sentiment at the extreme
should remember that when oil had been trading at $37 dur- which is required to see a major reversal. Time analysis points
ing 2003, expecting the commodity to reach a gain of more to October 14-17 or the last week of October as potential
than 400% also seemed unrealistic. In the current environ- turning points. We also have mid November as an extreme
ment anything is possible. cycle date. Combining timing with classical technical analysis
Historically we know that the months of September and should prove useful for technical traders.
October are disastrous for the stock market and this year is Once we have a firm low in place this would have complet-
no different. If we are to see a late rally then a break above ed a “phase one” which should be followed by “phase two”
5090 is required to turn the downward trend to an upward a corrective rally. This should take us into 2009 and then the
trend, at least in the short term for the FTSE 100. technical picture shows that another leg down could take
place as the “phase three” which could be very devastating.
Buying opportunity? Analysts such as Bob Prechter and Albert Edwards also have
Some analysts feel that the market is cheap and ripe for the come up with similar conclusions that the decline is not yet
investor to get in and pick up bargains. History has taught us over. It is possible that we could still see a further 20%
that trying to catch a falling knife is dangerous and should shaved off current levels in the next phase.
not be attempted. My view is that a significant reversal is
required where we see at least a higher close on a weekly price Sandy Jadeja is chief market strategist at ODL Markets
AUS/USD:
OUTLOOK TO THE DOWNSIDE
By Mohammed Isah
AUD/USD came in strongly off its recent low at 0.7802 to gle (a continuation chart pattern) which ultimately broke out
close higher at 0.8362 recently. This is coming on the back of a to the upside in Mar 2007.
collapse off its YTD high at 0.9851 in mid-July’08 (Figure 1).
Target of 0.9230 reached
Having decisively resolved to the upside, two technical issues
were triggered: the first being the resumption of its longer
term uptrend started in Sep 2001, and the second relating to
meeting its ascending triangle pattern price target at 0.9230
established by measuring the width of the pattern and pro-
jecting it from the breakout point. Although setbacks
through the breakout point and the 0.8005 level occurred in
Aug 2007 after the pair attained a high of 0.8873 in July 2007
(Figure 2), recoveries off the 0.7676 low (Aug 17 2007 low)
saw the pair resume its long term uptrend and later achieve
its breakout target at 0.9230. With the pattern of higher highs
and higher lows established, AUD/USD rallied to a high of
0.9851 in mid-July 2008 after a two-month corrective pull-
back was seen in Nov/Dec2007.
Overbought signals
With clear overbought signals displayed on both the weekly
and monthly charts (though parity status was looming fol-
lowing AUDUSD’s attainment of its highest price since
1983), the collapse off the mentioned high was technically
expected though the sell off was fast and deeper than envis-
aged.
Although the parabolic declines tested the 0.8005/0.7802
Source: ProRealTime
levels and turned back above there while key supports at the
Figure 1: Weekly Chart
0.9328 (June 2008 low), 0.8954 (Mar 2008 low) and 0.8512
Before the pair’s recent sell off, AUD/USD had enjoyed an (Jan 2008 low) levels remain unbroken, the medium term
uptrend dating back to Sep 2001 after a bearish trend struc- outlook continues to point lower implying its bounce off the
ture that began in Dec 1996 and bottomed at 0.4825/51 in 0.8005/0.7802 area is corrective of its weakness started at
April/Sep 2001. While pullbacks off its Feb 2004 high at 0.9851. Our medium term target resides at the 0.7676 level,
0.8005 were seen, and subsequent retests failed at the 0.7773 its Aug 2007 low and its 100 monthly EMA at 0.7570.
level in Nov 2004 and the 0.7872 level in Mar 2005, price On the other hand, as indicated above, a combination of
consolidation that ensued developed into an ascending trian- oversold conditions, parabolic declines, the formation of →
Tom DeMark
8 THE TECHNICAL ANALYST October 2008
Market Views
US STOCKS:
1973/74 REVISITED
A summary of Tom DeMark’s recent talk in London and his views on the markets
Monday October 6th saw Tom DeMark give another of his all-time high of 6700.
annual talks at the London offices of Bloomberg, part of a However, DeMark is not a charting purist. His rational for
whistle stop tour of the major European financial centres. the fall in US stocks next year is based on political-economic
These have proved to be very popular in the past but dramat- factors: namely, Barack Obama winning presidential election
ic events in the markets on the day threatened to dampen this year. Once he takes office in the White House next year,
turnout. In the end, DeMark need not have worried: atten- his administration will be perceived as being anti business and
dance was impressive with close to 200 hearing him give his pro higher taxation.
views on the markets and discuss his indicators.
CURRENCY ASSET
MANAGEMENT
We talk to Chris Charlton of Centa Asset Management about his multi-manager investment approach to
the foreign exchange markets
Conference Includes
Thursday 6 November Friday 7 November Saturday 8 November
Walkabout, traditional IFTA round Prof. Carol Osler (Brandeis University): Tony Plummer: the logic of non-
tables meeting analysis of stop-loss or
orders
ders rational behaviour in financial
Chistopher Neely (Fed de St Louis): distribution and its rrelation
elation to market markets
rrelationship
elationship between or
order
der flow and volatility Claude Mattern (BNP): strstrength
ength and
macroeconomic
macr oeconomic announcements on Y
Yasmina
asmina Hasanhodzic (MIT): limit of technical analysis : market
the for
forex
ex market demystifying and automating action, interpr
interpretation
etation and price
technical analysis and hedge-fund anticipation
2009 outlook by a panel of strategists
strategies Private visit of the museum and gala
Dinner cruise on the Seine Y
Yannick
annick Daniel (Société Générale): dinner at the Louvre
combining behavioural financial with
fundamental inputs in a hedge fund
Maxime V Viémont
iémont (BNP): hybrid trtrend-
end-
following strategies
Full pr
program
ogram on www
www.iftaparis2008.com
.iftaparis2008.com
TA: What is the difference between a FX multi-manager managers that we look at and search for ones that meet our
and fund of funds approach? criteria. We start using basis quantitative analysis and
progress through various stages of more complex due-dili-
CC: From the concept of modern portfolio theory, very lit- gence until we come out with a core number of managers
tle. Both look to reduce risk by diversification. The difference that suit our expectations.
lies in the scope of investment opportunities and the struc- To begin with we look at some traditional statistical analy-
ture of the investment vehicle. There are a vast number of sis such as absolute returns, maximum drawdown, Sharpe
currency managers available (CTAs) to choose from whilst and Sortino ratios. We then look at the managers’ trading
the number of currency funds is limited. As the name strategies and conduct look-back analysis to check their
implies, fund of fund managers can only invest in funds and robustness. An important part of this is the comparison
therefore the investment choice is limited. analysis with our own in-house benchmark portfolios. We
The difference in structure is more complex but there are also put great emphasis on qualitative analysis and this is the
a few important points. In many cases a fund of funds will next step: we look at factors such as staff turnover, risk con-
not be able to know its real exposure and results until all the trols and back up, administration, office location and others.
different funds have reported their own. Liquidity can be a Once we have arrived at a core number of managers we
problem and there can be restrictions on entry and exit. In then conduct personal visits. It is our intention to get under
our case - the multi-manager route - we have daily liquidity so the skin of the managers and really understand their plans
we can exit or change the portfolio on a daily basis as well as and targets, their fears and anxieties, their daily routines and
our investors. We have daily reporting so we know exactly pressures etc. We are specialists in behavioural analysis and
what each of our managers is doing and we can see our total this plays a large part in our due-diligence.
currency exposure. Another point is that a fund of funds may Finally we come up with a simple question, Can we trust
charge extra fees in that they often charge an extra manage- these guys with our money going forward?
ment and performance fee on top of the individual fund fees. As I have said, for the programme we have come to the
This can add up. At Centa, we do not charge any perform- conclusion that around ten managers is the optimal number
ance fee. to provide a variety of trading strategies that will perform in
most market conditions and provide us with steady growth
TA: What are the advantages of investing in a multi- within an acceptable risk profile.
manager fund rather than a single manager one?
TA: What’s different about your selection process com-
CC: This is classic portfolio theory; diversification reduces pared with other multi managers?
specific risk. By investing in a number of managers with dif-
ferent strategies, one can reduce the risk of the overall port- CC: We put a lot of emphasis on the behavioural aspect of
folio down to a certain point whilst still expecting to achieve managers not just the traditional statistical returns. We have
a satisfactory return. five members in our asset allocation committee all with over
thirty year’s individual experience in the markets. I believe
TA: Whose money do you manage and how much do that combined we are in a better position to judge managers
you have under management? and their strategies. That is our advantage.
CC: We have designed the product to be eligible for both TA: How do you decide on the weightings that you give
institutional and retail investors. There are different ways of each manager? Is it purely performance related?
reporting AUM. We launched the product in January and at
the present time we have $64 million under management. CC: Preferably we like to have a relatively even distribution
but there are cases where we will have lower or higher weight-
TA: Can you explain the process you go through in ings. If a manager has a high volatility then we will be biased
selecting your managers? to have a lower weighting despite the potentially higher
returns and vice-versa. In other words we are always looking
CC: We select our managers via the Deutsche Bank platform at ways of reducing risk and volatility rather than just produc-
called FXSelect platform and it is a perfect solution for an ing high returns.
investor who wishes to invest in a single manager or an index We will also look at the strategies: many managers will be
of his choice. One example is that the investor has a single active in all markets which means we have to look at their
contract with Deutsche bank rather than having individual individual exposures to certain currencies. We have our over-
ones with each manager. all limits to different currencies within the total portfolio and
We have decided that around ten managers is a suitable this will then affect the weightings of the individual man-
number for our programme. We have a universe of about 100 agers. →
TA: Why do you think there are so few fund of fund cur- Markets. Then we can look at their strategies: fundamental or
rency managers? systematic, short-term or long-term. Many managers build
complex models to assess yield differentials, economic funda-
CC: This is because it is only relatively recently that curren- mentals and so-on. Many use technical analysis. As you can
cies became a recognised asset class and therefore there are see there are many variations.
only a limited number of currency funds. I think you have to
differentiate between currency funds and currency managers TA: How do you assess the risk associated with each
(CTA programmes) of which there are many. We have creat- strategy?
ed a multi-manager programme that can be integrated into a
fund or another structured product. CC: This is an important point and we look closely at the risk
profile of each strategy. Most managers sets the risk level of
TA: What returns has the multi-manager programme their strategies by allocating a risk budget and setting stop
seen in the past 12 months. What is the Sharpe ratio? losses to ensure that the budget is not exceeded. Thus the risk
is not simply associated with a particular strategy, but also
CC: We launched the programme in the middle of January with its implementation.
this year and we are currently up 4.8%. I would like to stress
that the aim of our programme is to produce an annual TA: Are you looking for strategies that are uncorrelated
return of 5% over Libor. We are not expecting to see 20% with other asset classes, strategies and FX rates?
returns, and more importantly, we do not expect to see 20%
drawdowns. Looking back to 2004, the present portfolio has CC: Generally we can say that currency returns are uncorre-
a Sharpe ratio of 1.6 and has not had a monthly drawdown lated to the returns of other traditional asset classes such as
exceeding 2%. equities and bonds, but there are many situations where the
strategies may be correlated. An obvious example is the cor-
TA: What performance measures do you use to assess a relation between the yen-carry trade and the equity market
manager? performance, at least until recently.
We are not concerned whether the strategy is correlated to
CC: For performance we look at traditional quantitative other markets or not, rather that the strategy itself is robust,
measures such as Sharpe and Sortino ratios, drawdowns and has adequate risk parameters, and that we can feel confident
volatility. We also use a series of sentiment strategy bench- that we are protected should events change rapidly and the
marks to assess the success of manager strategies on a correlation unravels.
monthly basis. For example these can be based on yield, trend
or volatility. TA: What strategies tend to perform best in periods of
high volatility and/or market turmoil?
TA: You mention on your site that you look at the strat-
egy of a manager and assess if this is likely to continue CC: Short-term strategies tend to perform better in these
into the future. How do you assess whether a strategy is environments. The reason simply is that they have much
likely to perform well in the future? shorter profit and loss horizons. Although one can argue that
they could produce a series of small losses, the danger of
CC: If a manager has had a good year of returns it is not the large losses is reduced. This is typical of models that have
case at all that this will necessarily continue. A pure trend fol- more medium-term horizons and do not react quickly
lower will under-perform in a consolidation market and vice- enough to sharp moves in price or volatility. Therefore our
versa. The carry-trade was a simple bet in 2006 and the first portfolio contains some short-term trading managers.
half of 2007. Now it is far more complex. The main point
here is to look at the adaptability of the manager and how TA: What strategies and currencies have performed best
much experience he has had in the market. Managers mostly over the past 5 years or so?
can be put into two classes: fundamental or systematic. Either
way we like to see that the managers are dynamic in their CC: Certainly the carry-trade was the best performer, so long
approach to different market conditions. This is very impor- high-yielders and short the yen and CHF. In the last two years
tant. the US dollar gained prominence as a carry-trade currency as
US rates fell. This is being reversed now. It seems that the
TA: Can you give us some examples of the type of markets are not so straightforward anymore and the best
strategies employed by the managers? example of this is when one looks at many managers who
have “hockey-stick” performance records. In that I mean
CC: Firstly we can differentiate between what currencies they many years of positive growth and then a sideways move-
are trading. Let’s categorise them into G10 and Emerging ment over the last few years.
We deal in Futures, Options, CFDs, Bullion, Forex and Equities for Individuals,
Corporates, Hedge Funds, Introducing Brokers and SIPPs.
JDFNVRQ+RXVH6avile Row/RQGRQ:63:
For more information on Berkeley IQ-Trader or the services that Berkeley Futures Ltd offer please contact
Marc Quinn on +44 (0)207 758 4777 or by email at mquinn@bfl.co.uk or see our website, www.bfl.co.uk
Berkeley )XWXres Ltd is authorised and regulated by the )LQDQFLDO 6Hrvices Authority. Please note that dealing in equities, futures, options, foreign
exchange and &)'’s are all areas of investment in which it is possible to lose money. The risks attached to dealing in off-exchange products such
as foreign exchange and &)'’s differ from those attached to trading in on-exchange products. If you trade in any geared/contingent liability
product it is possible to lose in excess of the funds you may have put in as your initial deposit. Investing in any of the products mentioned may not
be suitable for you and if you are in any doubt you should consult your financial adviser.
Howe’s Limit
Techniques
Indicator Focus:
Rule
Howe’s Limit Rule isn’t an indicator as such; it is more
of a trading strategy. Nevertheless, the “rule” does
provide trading signals of a kind that can be used in
futures markets where there are limits on permissible
daily price ranges.
As a corollary, an unexpected limit move in the opposite on nearby contracts often become significant sup-
direction of the prevailing trend can be an early warning of a port/resistance points on weekly/monthly charts. Limits left
trend reversal (as everyone changes their minds at the same hanging in deferred contracts are specific to them only and
time). Finally, an abrupt limit move out of a accumulative or usually become irrelevant at expiration.
distributive congestion phase can signal the beginning of a
powerful new trend (as everyone tries to go through the same Exceeding the limit
door at the same time). According to the Moore Research Centre (MRCI), of key his-
On the rare occasion when a lead contract leaves a traded torical significance are the first and third days immediately
limit price "hanging" (not exceeded prior to its expiration), following a trade at a limit price. In a majority of those mar-
that limit price is carried over as a future objective for subse- kets a limit traded price has been exceeded on the first day
quent lead contracts. As such, it can become a magnet for following 50-70% of the time. In almost all markets studied,
intermediate- or long-term trend exhaustion. In other words, the analysis suggests the historical probability of exceeding a
the prevailing trend may be maintained and/or a new trend limit price is often greater than 80% within 3 trading days,
suppressed from beginning until that "hanging" limit is and 90% within 7 trading days.
exceeded, often creating a double top or double bottom.
This happens because the lead contract is most cash-con- Many thanks to the Moore Research Centre (MRCI) and Jim Wyckoff
nected and used on weekly/monthly charts. Hanging limits in the writing of this article.
Dimitri Speck of Seasonal Charts looks again at the cycle and how stock
markets may move as the election day approaches
Past performance may include measures financed through The vertical scale displays perform-
The direction of equity market prices is deficit spending and the (not complete- ance on a percentage basis. So in the
not really dependent on whether a ly independent) Fed supporting each first section of the chart above
Republican or a Democrat president is incumbent president through its mone- “Election” you see the average per-
elected. Recent presidential periods tary policies. But after the election formance of all election years, above
have shown solid equity markets under unpopular measures are piled on such “Post-Elect.” the performance of all
both Clinton (Democrat) and Regan as those designed to counter a sprawl- post election years is shown, above
(Republican). Thus the election cycle ing federal deficit. Figure 1 shows a typ- “Midterm” the performance during the
does not differentiate between political ical four-year election cycle going back middle part of the cycle, and above
parties but rather according to the year to 1897. “Pre-Election” the performance of →
of the presidency. During the last hun-
dred years or so the Dow rose on aver-
age 7.3% during a presidential election
year. In pre-election years it performed
on average an even better 9.3%. In con-
trast, in post-election years perform-
ance was only 3.4%, and in the subse-
quent mid-term years it was just 3.2%
on average. A comparable link between
equity market performance and the year
of the presidential election cycle already
existed during the 1800s. So, for a mar-
ket gauge it is a statistically well ground-
ed relationship.
Election year
Figure 2 shows the average perform-
ance during election years only. The
weakness during the first half of the
year is clearly visible. Then the Dow
rises during the second half of the year
in typical fashion with a high in
November with Election Day. So dur-
ing election years, stocks move exactly
opposite to their typical annual season-
al pattern when they usually increase
during the first half of the year and per-
form modestly during the second half.
For example, an average price move
of 0% can be made up of a 10% price
increase and a 10% price decline. The Figure 3.
OBSERVATIONS ON
LUNAR PHASE &
US PANICS
By David McMinn
An amazing correlation exists between the phase of the If we extend the timeframe back to 1910 and forward to the
moon and the timing of major US financial panics. Figure 1 present, we can add the events listed in Table 1
plots annual one day (AOD) falls1 greater than 4.25% for the
Dow Jones Industrial Average (DJIA) against the lunar cycle, AOD Fall Event DJIA
between 1915 and 1999. AOD falls in the DJIA greater than % Fall Phase Angle
4.25%2 have nearly always appeared in two quarter segments Jan 20, 1913 One day fall -4.90 153
of the lunar phase: between the first quarter and full moon Jul 30, 1914 Onset of WW1 -6.63 099
and between the third quarter & new moon, the only anom- Apr 14, 2000 Tech Wreck -5.64 130
aly being in 1930.3 Sep 11, 2001 WTC attack na 281
Jul 23, 2002 One day fall -4.64 122
LUNAR PHASE & MAJOR DJIA Jan 21, 2008 (a) Stock market panics na 169
ONE DAY AOD FALLS Sep 15, 2008 After Black Sunday -4.41 184
1915 - 1999 Sep 29, 2008 Bailout rejected -6.98 004
Table 1. (a) Worldwide stock market panics occurred on this day.
The US stock market was closed for the Martin Luther
King Jr holiday.
harmonics, although how this functions remains unknown. Where are we now?
And whilst it’s true that correlation does not equal causation, The 2007 to 2008 market crisis has historic parallels. The
these and many other correlations support a strong moon record DJIA high occurred on October 9, 2007, which was
sun affect on market activity. Such findings confirm the idea close to the September highs in 1895, 1899 and 1912. Each
that markets are cyclical and past activity is indeed indicative of the four highs was followed by a major crash 104 to 112
of future outcomes. days later (see Table 2) and a protracted market decline there-
If you list DJIA market highs by the year, they will not cor- after.
relate with lunar phase. However, if you list the highs by Market Interval 1 Day Fall
month – day (year ignored) excellent relationships can be High > 4.50% Interval Low
established. If the peaks at the beginning of a bear market
occur around the same month, the moon ans sun will be in 1895 (a) 107 days 1895 (a) 232 days 1896
similar ecliptical segments, giving rise to similar lunar phases Sep 04 Dec 20 Aug 08
and market outcomes. The best example occurs for the
September 3, 1929 and August 25, 1987 peaks, both of which 1899 104 days 1899 280 days 1900
took place just after the new moon and both were followed Sep 05 Dec 18 Sep 24
55 days later by spectacular October panics. The violent mar-
ket decline lasted only a few months, with the DJIA hitting a 1912 112 days 1913 556 days 1914
bottom on November 13, 1929 and December 4, 1987. For Sep 30 Jan 20 July 14
1929 and 1987, there was an interval of 717.0 lunar months
between the spring lows, the record highs, the autumn highs, 2007 104 days 2008 (b) ??? ???
the panics, the recoveries and the major post crash one day Oct 09 Jan 21
falls (Carolan, 1998, McMinn, 2006).
Curiously, major events in the current market have taken
place near the full and new moons (to within a day). Thus,
intervals between the events were all in whole and half num-
bers of lunar months.
References
Carolan, Christopher. Autumn Panics. The Market
Technician. Journal of the Society of Technical Analysts. p
12. July 1998.
McMinn, David. Market Timing by the Moon & the Sun.
Privately published. 2006.
© Copyright 2008. David McMinn. All rights reserved.
www.davidmcminn.com
Strategies 2008
30 Pavillion Road
London SW1
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Management Management
Value Investing
Behavioural biases play a dual role in the markets. Firstly, they can be viewed as
the biases that a trader or investor should try to avoid in order to take a more
rational and disciplined approach. Secondly, they can be viewed as the biases that,
en-masse, are played out in the market and can be exploited for profit. In this arti-
cle, The Brandes Institute looks at some of the most common biases that prevent
investors from taking a purely rational value-based approach.
brains get busy looking for ways to think about the experi-
ence that will allow us to appreciate it”. As examples, Gilbert
cites studies in which consumers, job seekers, high school stu-
“WE END UP PREFERRING dents, gamblers, and voters rated their appliances, jobs, col-
leges, horses, and candidates more positively after they pur-
BAD DEALS THAT HAVE chased, accepted, enrolled in, wagered on, or voted for them,
respectively.
BECOME DECENT DEALS TO
Challenging Facts
GREAT DEALS THAT WERE Once we have formed an opinion about something, it can be
difficult to change it. Often, our perceptions and hypotheses
ONCE AMAZING DEALS” become our realities – regardless of the facts. Gilbert notes
we tend to treat facts “unevenly” when confirming or chal-
lenging “our favored conclusion” and cites a study to illus-
trate this point. Volunteers were asked to judge the intelli-
trouble when they “compare with the past” by comparing a gence of another person.
security’s current price with its past price. Many investors When the person being evaluated was perceived to be
“anchor” on the purchase price for a security. For example, if “funny, kind, and friendly,” little evidence was required.
they buy a stock at $40 a share, they constantly compare its However, if the person being evaluated was perceived to be
performance with that original cost. Thus, if the stock price “unbearable,” volunteers required much more evidence.
drops to $30, they tend to get upset. But looking at a stock’s Thus, when we want to believe something, just a few facts can
current price vs. its purchase price is only one way to make a convince us. As such, people would be wise to actively seek
comparison. If the value of the business remains $70 per out information that counters our conclusions when making
share, a decline to $30 represents an even greater discount – investment decisions. And we should seek a great deal of this
and perhaps an opportunity to purchase additional shares. countering information.
In an example, Gilbert writes that “. . . people are more
likely to purchase a vacation package that has been marked Valuing Things Differently
down from $600 to $500 than an identical package that costs Why can it be so hard to be a patient investor? Gilbert may
$400 but that was on sale the previous day for $300. Because offer some insight when he writes, “The fact that we imagine
it is easier to com- the near and far
pare a vacation pack- futures with such dif-
age’s price with its ferent textures causes
former price than us to value them dif-
with the price of ferently as well”. He
other things one cites an example of
might buy, we end up paying for a
preferring bad deals Broadway show tick-
that have become et. Most people
decent deals to great would be willing to
deals that were once pay more for a ticket
amazing deals”. to a show tonight
than a ticket to the
Disambiguating same show next
Experience month. “Delays are
There is an old Wall painful,” he writes,
Street adage, “Never “and it makes sense
get emotional about stock.” Great advice – but very difficult to demand a discount if one must endure them.” But he adds
to put into practice. According to Gilbert, there is a reason that studies show when people imagine the pain of waiting,
why we tend to get emotional – our brains take life’s ambigu- they expect it to be far worse in the near term vs. the long
ities and reshape them into “good” things or “good” experi- term. “And this,” Gilbert contends, “leads to some rather odd
ences once we are personally involved. A stock in the United behavior”. For example, most people would rather get $20 in
States, one of thousands of securities we could own, is rather a year than $19 in 364 days. Apparently, a one day delay that
ambiguous – until it’s in our portfolio. At that point, investors takes place in the far future looks (from here) to be a minor
may get emotional about their holdings. According to inconvenience. But – most people would rather receive $19
Gilbert, “. . . as soon as we have a stake in its goodness – our today than $20 tomorrow because a one-day delay that →
takes place in the near future looks (from here) to be unbear- 1. You own shares in Company A. During the past year, you
able. considered switching to stock in Company B but decided
“Whatever amount of pain a one-day wait entails,” Gilbert against it. You now find that you would have been better
writes, “that pain is surely the same whenever it is experienced; off by $1,200 if you had switched to the stock of
and yet, people imagine a near-future pain as so severe that Company B.
they will gladly pay a dollar to avoid it, but a far-future pain as
so mild that they will gladly accept a dollar to endure it”. 2. You also owned shares in Company C. During the past year
Value investing likely will not trigger that part of our brain you switched to stock in Company D. You now find out
that generates feelings of pleasure in the short term. (Such that you’d have been better off by $1,200 if you kept your
feelings of excitement help drive gamblers into casinos, not stock in Company C.
into value managers’ offices). Value investing often doesn’t
feel exciting or pleasurable. That’s because it’s not a short-
term, get-rich-quick approach to the markets. But it is impor-
tant to know that our short-term emotional responses can VOLUNTEERS WERE ASKED TO
affect our long-term rationality.
JUDGE THE INTELLIGENCE OF
The Least Likely of Times
People tend to remember specific, infrequent experiences. We
ANOTHER PERSON. WHEN THE
tend to remember the best and worst of times vs. most of the PERSON BEING EVALUATED WAS
times. And this can affect decision-making. For example,
Gilbert highlights how our reaction to the way a movie ends PERCEIVED TO BE “FUNNY, KIND,
influences our perception of the entire film. “The fact that
we often judge the pleasure of an experience by its ending AND FRIENDLY,” LITTLE EVIDENCE
can cause us to make some curious choices”. There are par- WAS REQUIRED. HOWEVER, IF
allels when investing: We might tend to remember with
greater clarity the bad investments we have made – especially THE PERSON BEING EVALUATED
if they have happened recently and ended with great pain
(large losses). The sharp emotions connected with these WAS PERCEIVED TO BE “UNBEAR-
short-term experiences may affect our long-term investment
approach.
ABLE,” VOLUNTEERS REQUIRED
MUCH MORE EVIDENCE.
Paradise Glossed
Perhaps we have heard the theory that negative events can
have twice the emotional effect as positive events. For exam-
ple, a $10,000 investment gain might earn us one “point” on Which scenario causes more regret? Nine out of 10 people
an emotion based scale. However, losing $10,000 when expect to feel more regret by switching. But Gilbert notes, “. .
investing would feel like losing two points. Same amount of . in the long run, people of every age and in every walk of life
money involved – but twice the emotional impact when los- seem to regret not having done things much more than they
ing money. This may be true, yet Gilbert argues that the regret things they did. . . ”. Thus, not switching stocks (scenario
human spirit is very resilient. He writes, “The fact is that neg- 1) causes more emotional stress. Why? We tend to reward our-
ative events do affect us, but they generally don’t affect us as selves mentally for taking action – even if it’s the wrong action.
much or for as long as we expect them to”. So this is great Our “psychological immune system” has trouble making us
news, right? So why do we still have such trouble focusing on feel good about inaction. In other words, doing nothing rarely
the long term? The answer: we continually subject ourselves feels very good. This is another reason why value investing
to an assortment of short-term stimuli. can be so difficult. Often, long-term success depends upon
Successful value investors may remember a handful of inaction. But not taking action may trigger sharp pangs of
clunkers, but, over time, the short-term emotional pain asso- regret – especially in the short term if prices for holdings
ciated with these few holdings fades when they realize their decline. The successful value investor may have to wait three
long-term success. Yet it can be difficult to shed the emotion- to five years or more to be rewarded. That can be a long time
al drag of short-term pain when we expose ourselves to it so to “do nothing,” a long time for regret to build.
frequently.
Brandes Institute Research Paper No. 2007-05, August 2007. This
Looking Forward to Looking Backward material was prepared by the Brandes Institute, a division of Brandes
Gilbert uses two investment scenarios to illustrate the influ- Investment Partners®. Please visit www.brandes.com/institute for the
ence of regret: full version, (also available from www.ssrn.com).
VOLATILITY TRADING
USING THE VIX
By Carley Garner
The adage ‘buy low and sell high’ was originally used in refer- ters ultimately comes down to timing of entry along with a
ence to price, but can also be applied to the practice of trad- good understanding of volatility, market sentiment and mar-
ing volatility. In fact even if you do not trade volatility ignor- ket knowledge. Additionally, experience, instinct and, of
ing measures of potential explosiveness while entering or course, luck will also come into play. Yet, in my judgment
exiting a market could mean financial peril. While many option selling is a superior strategy in the long run.
traders understand the concept of buying options during Options selling advocates and equity market volatility
times of low volatility and selling them during times of high traders seem to migrate to the S&P 500 futures market. Both
volatility, emotions often lead a well planned strategy astray. the full sized and mini versions of the contract provide ample
Unlike traders that are looking to profit from a directional liquidity to actively trade the market without the burden of
move in price, volatility traders are more interested in the unreasonable bid/ask spreads.
pace at which the market is moving than in its direction.
However, it is important to chart both price and volatility. CBOE's Volatility Index (VIX)
Doing so provides trades with a better understanding of the An important measure of volatility when referring to the
'big picture'. S&P is the now infamous Chicago Board Options
In my opinion, the most efficient means of trading US Exchange's Volatility Index, often simply referred to as the
equity market volatility isn't through the VIX index or any VIX. According to the CBOE, the VIX is a "key measure of
other similar measure. Liquidity is a major factor working market expectations of near-term volatility as conveyed by
against the viability of doing so. Instead, I believe that traders S&P 500 stock index option prices" and has become one of
should look to buy or sell options on S&P 500 futures. The the most prominent measures of market sentiment in the
S&P is a broad based index and its value is sharply impacted world. Before 2007 the VIX spent a majority of its time
by market sentiment and the corresponding volatility. Thus, a below 20, it is now obvious that times have changed....at least
trader that is of the opinion that volatility will increase may for now.
look to buy volatility through the purchase of options writ- Keep in mind that there were adjustments made to the
ten on S&P 500 futures, and those looking for volatility to parameters of the index in 2003 that may have arguably
decrease may look to sell volatility by going short options on affected the value of the index. For our purposes we will dis-
the index. regard the possible discrepencies.
It is important to note that increased values of VIX are
Trading Volatility through Premium Collection highly correlated with higher option premium in the form of
As mentioned, one way to speculate on variations in volatili- higher implied volatilities and are ideal conditions for an
ty is through the practice of option selling, often referred to experienced option seller assuming that they are willing to
as premium collection. Option sellers are in the business of accept the risk of participating in such a market.
collecting premium, much like an insurance company, under
the assertion that in the long run the premium collected The Quest for Implied Volatility
should outweigh any potential payouts. This theory is based Unlike the VIX which is derived from the underlying futures
on the assumption that more options than not price among other factors, implied volatility is a component
expire worthless which has been suggested by several studies of option price. The implied volatility of an option, is the
including one conducted by the Chicago Mercantile amount of volatility implied by the market value, or price, of
Exchange. Unfortunately, just as insurance companies are the option. In other words, the implied volatility is forward
sometimes forced to honor their policies on excessive claims, looking in that it incorporates the current market precarious-
option sellers are vulnerable to monster market moves than ness as well as what market participants are expecting at some
can be potentially account threatening. Preventing such disas- point in the future.
You may also find that market emotion and sentiment are For example, based on this assumption put sellers may
a component of implied volatility. As traders scramble to go have fared well during the lows in 1998, 2001, 2003 and 2007.
long volatility through the purchase of options in an attempt That is of course assuming that the trader wasn't early in his
to profit from the latest hype, option premiums can and do entry. If a short volatility trader enters a market prematurely,
explode exponentially. As a sidelined option seller, these there is a strong possibility that the trader will be forced out
types of conditions should be inviting. The premise of this of the market prematurely due to lack of financing or mar-
approach is to attempt to sell options to buyers that are sim- gin. Let's take a look at an example of a trader that is inter-
ply "late to the party". The key is making sure that as a sell- ested in selling volatility by going short S&P puts.
er you aren't too early. Beginning in the middle of 2002 and throughout the begin-
ning of 2003, put sellers with savvy timing may have done
Selling Puts can be Lucrative, but it Comes with very well. However, trading is a game of risk and those sell-
a Hefty Price Tag ing puts during those times were accepting great amounts of
It is often the case that selling puts is more lucrative than risk in order to reap the reward.
calls, but the added reward carries baggage in the form of Let's take a look at a continuous S&P 500 futures chart
additional risk. Due to the increased levels of risk, timing during the 2002/2003 lows in Figure 2. While the VIX is a
becomes crucial. By nature an option selling program tends great indication of volatility and extreme market sentiment, it
to leave room for error in the execution. Nonetheless, being is also helpful to look at indicators of volatility such as stan-
short puts in a spiraling market can quickly change that. dard deviations. Luckily, the creation of Bollinger Bands
The phenomenon of put premium in the stock indices allows us to visually determine market volatility through the
being larger than call premium is often referred to as the line plot of two standard deviations from its mean. Times of
volatility smile. The volatility smile is a long observed pattern high volatility are denoted by wider bands, or a larger stan-
in which at-the-money options have lower implied volatility dard deviation, and times of decreasing volatility result in
than out-of-the-money options along with the argument that narrowing bands.
there is more value in owning a put relative to an equally dis- As market volatility increases, so will option prices. During
tant call. This scenario seemed to be born after the crash of such times, option buyers are forced to pay extremely high
1987 in the U.S. prices for options that in theory are more likely to expire
While there are no crystal balls to let us know when a mar- worthless than not. On the other hand, option sellers are pro-
ket will turn around and how low that it may go before it vided top dollar for accepting theoretically unlimited risk.
does, being aware of historical patterns in price, volatility and
market sentiment may help to avoid a compromising situa-
tion. Let's take a look at the relationship between the VIX
and the S&P.
"IT IS
IMPORTANT TO
CHART BOTH
PRICE AND
VOLATILITY."
Figure 1.
Higher premiums collected not only increase a traders
VIX and the S&P 500 profit potential but it also increases the room for error. The
Looking at Figure 1, it is obvious that the S&P 500 has been money collected for a short option can be viewed as "cush-
able to forge recoveries during times of spiked volatility as ion" in that it defines the amount in which the trader can be
measured by the VIX. Armed with this knowledge, it may be wrong and still make money by shifting the reverse break
a viable strategy to look at erratic, and many times irrational, even further from the market. The Reverse Break Even
trade as a point of entry for put sellers. (RBE) of a short put is calculated as follows:
Figure 3.
At expiration, this trade would yield the maximum profit of
Figure 2. $1,075 before commissions and fees if the futures price is
above 680 (see Figure 3). Ignoring transaction costs the RBE
RBE = Put Strike Price - Premium Collected + on the trade is at 675.7. This simply means that this particu-
Commissions and Fees lar trade makes money with the futures price trade anywhere
above 675.7 before commissions and fees. Please note that
As you can see, the more money that the option seller col- the amount of commission paid will reduce the premium col-
lects, the deeper-in-the-money the option can be at expira- lected and shift the RBE closer to the market. To look at it in
tion without resulting in a loss to the trader. another perspective, the trader can be wrong by 104.3 points
According to the hypothetical data available to us, in July of after entering the trade and still manage to break even. If the
2002 with the September futures price near 780, it may have trader's goal is to put the odds in their favor, this seems to be
the solution.
Conclusion
Without regard to transaction costs, trading is a zero sum
"THE S&P 500 HAS game; for every winner there will be a loser. Thus, putting
your odds ahead of those of your competition is a must. In
BEEN ABLE TO my opinion, selling options during times of high volatility
while exercising patience and incorporating experience is
doing just that.
FORGE RECOVERIES With that said, where there is reward there is risk; in effi-
cient markets you cannot have one without the other. This
strategy should only be attempted by those that have ample
DURING TIMES OF risk capital to allow for potential draw downs as well as the
ability to manage fear and greed. Fearful traders are vulnera-
ble to panic liquidation at inopportune times in terms of
SPIKED market volatility and option pricing. Likewise, greedy traders
are tempted to sell options closer-to-the-money in hopes of
VOLATILITY." higher payouts but the risk may turn out to be unmanageable.
I strongly believe that less is actually more when it comes to
premium collection. Trade less, collect less and hopefully
enjoy more success.
been possible to sell the August S&P 500 futures 680 put for
$4.3 in premium which is equivalent to $1,075 before com- Carley Garner is the Senior A nalyst of DeCarley Trading LLC where
missions and fees. If this was the case, a trader could have she also works as a broker. Her book, "Commodity Options" published
collected a little over a thousand U.S. dollars for an option by FT Press will be on shelves in January 2009. V isit
that was, at the time, approximately 100 points or nearly 13% www.DeCarleyTrading.com for your free subscription to Carley's e-
out-of-the-money. newsletters and for details on the services she provides.
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TD-Wave
Techniques
Tom DeMark is adamant that subjective methods used in technical analysis can-
not be trusted. When technical analysts cannot agree amongst themselves how to
draw them, how can they be tested and how can be people be confident in using
them? Perhaps the most subjective of all technical analysis methods is Elliott
Wave analysis. There is a joke amongst technical analysts - bring together five
Elliott wave analysts and you will get ten views on the markets. Yet all these ana-
lysts use the same technique with the same rules.
Tom has distilled this technique into a strict set of rules and measurements, so
strict that a computer can calculate them and display them, marking up the wave
counts according to defined rules. With his rules, everyone sees the same thing and
makes the same correct count (if you agree with his rules). Elliott wave is now
objective and mechanical - This is Tom DeMark’s D-Wave.
D-Wave displays waves according to the following logic: Screen shots of D-Wave on Bloomberg
For Up-Waves,
High of 1 is less than the low of 4, and
High of 1 is less than the high of 3, and
High of 3 is less than the high of 5.
For Down-Waves,
Low of 1 is greater than the high of 4, and
Low of 1 is greater than the low of 3, and
Low of 3 is greater than the low of 5.
Level / Price,
Wave Start-21 Low
Wave 1-8 High DeMark D-Wave for the S&P500
Wave 2-5 Low
Wave 3-13 High Wave Properties
Wave 4-8 Low
Wave 5-21 High
Wave A-13 Low
Wave B-8 High
Wave C-21 Low
The reverse logic applies for sells.
Price Projections
Price projections are created based on the length of a wave
and Fibonacci extensions. To calculate the projection, you
must obtain the difference of the prices between waves.
Obtain the difference between the "Wave Validation" prices -
the "From" and "To" waves, then multiply that value by the
Fibonacci number in the "Times" category. The resulting
value is then added to the "At" wave start for an Up wave
and subtracted from the "At" wave start for a down wave.
Example
To calculate the Wave 3 Objective, take the difference
between the start and end of Wave 1 equalling 10 points.
The difference is then multiplied by 1.618, resulting in a
value of 16.18. In a down sequence, this value would be
deducted from the start of Wave 2, equalling 40 in the
above example. The Wave 3 price objective would be 23.82.
As always with Tom DeMark’s work, the most valuable ben-
efit of using this indicator is to help you identify low-risk
buy and sell trading zones. D-Wave takes a difficult and
highly subjective technique and turns it into a rule-based
method. It offers the flexibility of deciding what and how
you want the rules to be enforced but then will accurately
implement them.
SIZING UP A SUPERPOWER:
A SOCIONOMIC STUDY OF RUSSIA
By Alan Hall
Elliott Wave International analyst, Alan Hall, uses Robert Prechter's principle
of Socionomics to tie events in Russian history to Elliott Wave cycles, and
explains why his analysis has serious implications for Russia and its neighbours
going forward.
and the decaying tsarist autocracy exacted terrible social costs. economic and social damage. From 1914 to 1921, Russia’s
Russia had the highest mortality rate in Europe and a lower population crashed more than 22 percent. Industrial output
literacy rate than England 163 years earlier in 1750. dropped 87 percent between 1913 and 1922, and gross crop
The effects of negative social mood worldwide led to yield fell by more than half. From these depths wave V in
World War I in 1914. By its end, 3.3 million Russians had social mood emerged, but due to the form of government
died, by far the largest death toll of any combatant nation. that took over in wave IV, Russia’s recovery was much slow-
The massive social and political chaos at the end of wave IV er than the rising social mood would have produced in a freer
decimated manufacturing, foreign trade, agricultural produc- society.
tion and Russia’s already poor per capita income, which fell
over 70 percent. 1920-1929: Cycle Wave V of Supercycle Wave (III)
Radicalism tends to emerge and become entrenched in cor- In 1921, the year after the rise of wave V began, Lenin aban-
rective waves. Marxism was Cycle wave IV’s radical idea. It doned attempts at communal agriculture and allowed individ-
encouraged the Russian Revolution of 1917, which ended the ual farming. The following year, the U.S.S.R. was formed. By
reign of the Tsars and eventually led to a savage civil war. 1926, agricultural output had returned to at least the pre-rev-
In 1918, as the five-year civil war wore on and wave IV olution level of thirteen years previous, and industrial output
approached its nadir, Lenin narrowly survived an assassina- did so two years later. Compared to those in the West, most
tion attempt. Shortly afterward came the successful assassina- economic recoveries in Russia look like half-hearted relief
tion of a secret-police chief. Lenin then instituted a policy of rallies. That was certainly true of Supercycle wave (III), and it
open and systemic mass terror. His handwritten “Hanging left little for wave (IV) to draw upon.
Order” of August 11, 1918 began the “Red Terror” cam-
paign. This edict illustrates how a bear market of
Cycle degree accommodates Russia’s tendency toward
social extremes, in this case with fear, recrimination and "NEGATIVE SOCIAL THEMES DUE
scapegoating:
TO APPEAR IN ANY APPROACHING
11 VIII 1918 BEAR MARKET FIRST EXPRESS
Send to Penza To Comrades Kuraev, Bosh, Minkin and other Penza
communists THEMSELVES IN MILDER FORM IN
Comrades! The revolt by the five kulak volosts must be suppressed with-
out mercy. The interest of the entire revolution demands this, because we
THE PRECEDING FOURTH WAVE OF
have now before us our final decisive battle “with the kulaks.” We need ONE LESSER DEGREE."
to set an example.
1) You need to hang (hang without fail, so that the public sees) at least
100 notorious kulaks, the rich, and the bloodsuckers.
2) Publish their names. 1929-1948: Supercycle Wave (IV)
3) Take away all of their grain. The following quote describes how some points in the Elliott
4) Execute the hostages — in accordance with yesterday’s telegram. wave pattern allow unique social forecasting:
This needs to be accomplished in such a way, that people for hundreds of
miles around will see, tremble, know and scream out: let’s choke and Forecasting Styles of Social Events
strangle those blood-sucking kulaks. Here is another esoteric point but one of great value. A section on
Telegraph us acknowledging receipt and execution of this. “Nuances” in Chapter 15 of The Wave Principle of Human Social
Yours, Lenin Behavior explains that negative social themes due to appear in any
P.S. Use your toughest people for this. approaching bear market first express themselves in milder form in the
preceding fourth wave of one lesser degree. Stop for a minute until you
TRANSLATOR’S COMMENTS: Lenin uses the derogative term get this idea. Here is a more detailed explanation: Social mood repeat-
kulach’e in reference to the class of prosperous peasants. A volost’ was edly traces out five waves up followed by three waves down. The negative
a territorial/administrative unit consisting of a few villages and sur- themes in “wave four” within the “fives waves up” presage those that
rounding land. (Library of Congress, http://www.loc.gov/exhibits will dominate, more dramatically and on a much bigger scale, in the
/archives/ad2kulak.html) ensuing “three waves down.”
It is also true of the character of social events. In an earlier fourth
Scholars estimate that Lenin’s campaign caused the execu- wave from 1916 to 1921, collectivists took over Russia. In the larger
tion of up to 200,000 people between 1918 and 1921. The fourth wave that followed, from 1929 to 1949, collectivists took over
concurrent civil war took the lives of seven to eight million nearly half of the earth’s population, in Germany, Italy, Eastern
people, five million of whom died by famine. Europe and China. (The Elliott Wave Theorist, September 2001.)
Overall, Cycle wave IV (1892-1920) wreaked tremendous Sure enough, the collectivism and social repression →
that emerged in Cycle wave IV (1892-1920) foreshadowed workers and even parents. The economic costs
what was to come in Supercycle wave (IV). were immense, as the state killed the brightest or hauled
Even at the peak of Supercycle wave (III), the Soviet econ- them off to the gulag. Fear stifled innovation, experimenta-
omy was unable to support the growth of industry and tion and constructive criticism and played a dominant
armed forces. Foreign investors were not interested in the social role.
country, and the middle class had been exterminated. Stalin, Fear is a key aspect of negative social mood. While democ-
who took power after Lenin’s death in 1924, had few sources racies typically oust leaders in bear markets, dictatorships
of revenue. He decided to plunder the 78% of the popula- seem to thrive on bear market fear. Stalin died a natural death
tion in the private agricultural sector. In 1929, at the onset of in office in 1953 while apparently planning yet another purge
Supercycle wave (IV), he began transferring control of farms, of top men in his government.
equipment and livestock to the government.
Farmers considered this policy a return to serfdom. They 1948-1965: Supercycle Wave (V)
resisted and destroyed about half the U.S.S.R.’s livestock — The upsurge in positive social mood in wave (V) pulled
some 55 million horses and cows — whereupon Stalin Russia out of its worst depths. From the turbulence of
responded by sending about a million families into exile. This Supercycle wave (IV), the communist state engineered a
conflict, and a catastrophic decline in grain production, exac- weapons and space program that gave it superpower status.
erbated the famine of 1932-1933 that killed between five and With Stalin gone, the Communist Party resurged. In 1953,
ten million people. Nikita Khrushchev was confirmed as head of the Central
Stalin’s move to bring farmers under state domination Committee, and change was in the air.
revealed the classic bear market trait of the desire to control Social mood can make or break political careers, and the
people. By most accounts, Stalin was rude, ruthless, unforgiv- politicians that thrive are either lucky or canny enough to ride
ing and without pity or empathy, and as the powerful wave the winds of change. Prior to Stalin’s death in 1953,
(IV) bear market accelerated, his malevolence expanded dra- Khrushchev was a devoted Stalinist. In the 1940s, near the
matically. end of wave (IV), his participation in Stalin’s purges earned
Stalin’s purges and deportations were a huge magnification him the nickname “The Butcher of the Ukraine.” But
of Lenin’s “Red Terror” campaign of the preceding fourth Khrushchev would soon put this past behind him.
wave of one lesser degree. His massive social repression With perfect timing, in 1956, near the middle of wave I of
spanned the period from 1929 to 1949, all of Supercycle (V) in Figure 1, Khrushchev read a speech, “On the
wave (IV). His purges were initially aimed at the most pros- Personality Cult and its Consequences,” denouncing Stalin
perous peasants (or “kulaks”) who resisted collectivization, and weakening the Stalinists in the government. This marked
but they expanded into a genocide in which tens of millions the beginning of the “Khrushchev Thaw,” a socially more
were starved, exiled or killed. This wave also amplified anoth- positive period in which the Soviets partially reversed repres-
er fixture of Cycle wave IV, the “katorga,” the predecessor of sion and censorship, improved relations with the West and
the Gulag labor camp. released thousands of political prisoners from the Gulags.
Supercycle wave (IV) ultimately gave rise to World War II. During and just after Supercycle wave (V), the U.S.S.R. was
The U.S.S.R. suffered the deaths of nearly 24 million civilians first in a number of critical space successes, including the
and soldiers (13% of the population) at the hands of the launch of Sputnik into orbit and the first space walk. The
Axis. U.S. and U.S.S.R.’s achievements in space were an astounding
The social environment today is so radically different that expression of positive social mood that has not been equaled
few people can imagine the destructive power of a in the 35 years since. In the list of positive aspects of social
Supercycle fourth wave. Photos of the kind that appeared in mood in chapter 14 of The Wave Principle of Human Social
1940s-era Life magazines — of the dead, wounded and gan- Behavior, we see the ones that made this achievement possi-
grenous — simply are not published in any mainstream ble: adventurousness, clarity, confidence, constructiveness,
media today. daring, desiring power over nature, embrace of effort, opti-
Stalin executed millions of comrades and other mism, practical thinking and sharpness of focus.
Communist Party members, officers and even heroes in It’s no coincidence that the U.S.S.R.’s moon landing came
the Soviet Army — anyone who might have threatened his the year of the top in the powerful 1965 Supercycle wave (V)
power. He used fear, anti-Semitism, racial polarization, peak in U.S. stocks. Three years later, as the achievements
starvations and secret police to consolidate his power so deriving from a positive social mood peaked, the U.S. put
firmly that no political opposition was possible. He used men on the moon.
scapegoats to cover his failures and re-wrote history
to his advantage. His police state forced Russians into sub- 1965-1982: Supercycle Wave (a)
mission. His impetus to “cleanse” society escalated into mass Conciliation and inclusion characterize large degree wave
hysteria, in which people denounced their neighbors, co- peaks, and the peak of wave (V) brought about a cluster →
The Wave Principle guarantees reliable forecasting only of probabilities. found prosperity into a growing military confidence include
It allows us to predict some aspects of the future and not others. For the recent conflict with Georgia, resumption of bomber
example, early in a new social mood trend, we can forecast society’s com- flights along the US East Coast, a new air defense system,
ing character changes but not necessarily specific events. We can forecast new offensive weaponry such as nucleur submarines and
that a major rising impulse wave will bring an increase in goodwill and ICBMs, and recent announcements that the Russian Navy
productivity. The specific decisions that each man makes and the specif- will return to the Mediterranean Sea through a port in Syria.
ic social actions and events that result depend upon countless details and In 1999, Putin told the Russian Federal Security Service
are therefore chaotic. As the trend progresses, however, we can watch for (FSB), “A few years ago, we succumbed to the illusion that we
signs to indicate such specifics and actually anticipate some of them quite don’t have enemies and we have paid dearly for that.” One
well, as demonstrated in Chapter 17. (The Wave Principle of Human spokesman described Russia’s changing mood this way: “In
Social Behavior, Robert R. Prechter, Jr. New Classics Library, 1999. Gorbachev’s time Russia was liked by the West and what did
Chapter 20, p. 404.) we get for it? We have surrendered everything: Eastern
Europe, Ukraine, Georgia. NATO has moved to our bor-
ders.” (Economist)
Social Implications
The stock market is our best indicator of social mood, so a
stock market forecast is first a social mood forecast, which
implies a commensurate change in the social environment.
Wave IV from 1892 to 1920 in Figure 1 retraced about 30
percent of the previous wave III that began in 1865. Wave
(IV) from 1929 to 1948 retraced about 40 percent of the pre-
vious wave (III) that began in 1859. Those declines accompa-
nied the extreme Russian social history described earlier.
They brought intense social repression, redirection of capital
from infrastructure to weaponry, and war and death on a
massive scale. Although the coming bear market has started
from a much higher point, realization of our forecast for a
large-degree decline in the RTSI will have major negative
effects on Russia, her neighbors and perhaps the rest of the
world.
A long-term trend toward a positive social mood leads to
peace and political cooperation, and an extreme trend change
in social mood toward the negative yields turmoil. A situation
where social mood in both the U.S. and Russia is in decline
would be quite different from the Cold War that occurred
during a bull market.
Russia’s long history of border wars and its desire to
reclaim the resources of satellite states lost upon the collapse
of the U.S.S.R. make future border conflicts likely. NATO,
Russia in positive mood. Putin’s approval rating is Muslim and Asian countries border Russia on the west and
nearly 80%. south. The ethnic diversity within these states represents con-
flicts-in-waiting for the xenophobia that attends bear mar-
Russia seems more ready to confront the U.S. today than at kets.
any time since the Cuban Missile Crisis, 45 years ago. Indeed, Much as investors descend a “slope of hope” in a bear
on October 26, Putin made a comparison to that dangerous market, we can expect the popular media to continue to
time, reversing the protagonists’ roles, with the U.S. this time underestimate the seriousness of Russia’s steady resurgence
placing missiles at Russia’s doorstep via the European missile to the world’s second largest military power. One should
defense shield. The steadily increasing potential for conflict remain alert to the patterns unfolding in the stock markets,
between the two superpowers represents the potential for the primary indicators of this social mood progression, and
serious trouble. On November 20, Putin warned that Russia to social and political events in Russia.
will react to a NATO military buildup on its borders. (BBC)
Social mood change at large-degree turns is not instanta- Extracted from A lan Hall, November 2007, “Sizing up a
neous. It can seem broad and slow as it develops. Recent top- Superpower: A Socionomic Study of Russia”, Parts I & II, Elliott
ics in the news that show how Russia is converting its new- Wave International.
2008
Strategies for 30 Pavilion Road
exploiting market
inefficiencies London SW1
Behavioural Finance 2008 is a one day event for Who should attend: Topics include:
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to learn about and discuss the latest and most
effective techniques in behavioural finance.
Speakers include:
Commodities Technical
Strategy at UBS Investment
Bank in London. He and his
team provide short and medi-
um term trading strategies and
bespoke educational training
sessions for clients. His area of
expertise for the past 14 years is
the DeMark suite of market
timing indicators and he is the
author of Bloomberg Market
Essentials: DeMark Indicators
(Bloomberg Press).
TA: What was you motivation for writing your book on it doesn’t give you an insight into the magnitude of the
DeMark indicators? expected reversal. I find that when using TD Sequential on
multiple time frames, combining it with TD D-Wave puts the
JP: I was approached early last year by David Keller (then signals into context – i.e. are we mid-way through the impul-
head of technical strategy at Bloomberg, now Director of sive stage of a trend or in the latter part and therefore termi-
Technical Strategy at Fidelity in Boston). Bloomberg was nal phase when a macro move is more likely? Typically, I find
thinking of producing a series of definitive books based on that TD Sequential signals in TD D-Wave 3 (the impulsive
market timing and technical analysis techniques and David phase of a trend) are less reliable than TD Sequential signals
asked if I would be interested in writing a user guide to the in TD D-Wave 5 (when the bulk of the trend has already hap-
DeMark indicators. pened).
I suppose like many authors, I was adamant that it was As far as which indicators are more or less effective than
never my intention to put pen to paper, but over the years a others, I think it’s more a question of what one’s investment
number of UBS clients around the world had asked for edu- objective and time horizon is. Tom has both trending and
cational material covering the popular DeMark indicators, so trend exhaustion indicators in his suite of tools so in my
this was a great opportunity to address that demand. It was opinion, it’s more a question of finding the DeMark indica-
also a chance to answer a number of questions that people tors that suit the individual’s objectives and personality – as
consistently ask about DeMark’s work when they start using the old trading adage goes – your chosen methodology
the indicators. Furthermore, very little information was avail- should be defined by whether you wish to eat well or sleep
able about TD D-Wave (developed by Tom DeMark as an well. I don’t mean that flippantly: for example, counter-trend
objective and mechanical version of Elliott Wave), which was trading is by definition counter-intuitive, so if you don’t like
to do so personally because I’ve been using them real-time Combo versus just using the TD Sequential?
for the past 14 years and have seen how they behave in all
types of environment. Suffice to say, while I recognise the JP: Frankly, I always struggled to determine when one should
indicators are by no means infallible or indeed the Holy Grail, use TD Sequential rather than TD Combo and vice versa.
I do believe they give one a considerable edge when it comes Obviously, it gives one a greater sense of confidence if the
to market timing if used in an objective and disciplined man- TD Sequential and TD Combo happen to generate a signal
ner over time. simultaneously, but since both indicators are trying to identi-
A number of very smart people have tried to back-test the fy trend exhaustion points it can be difficult rationalising a
indicators, but I should say that Tom is keen to emphasise preference for one over the other.
that his body of work is indicators, not trading systems. So
for TD Sequential, one does get an entry signal and an initial However, a couple of things do stand out:
risk level but DeMark doesn’t provide information on how to
manage the risk once the trade starts moving in your direc- 1) DeMark suggests TD Combo has a slight edge over TD
tion or advice on where to take profit. So if you did want to Sequential if one is trading off intra-day charts,
back-test the TD Sequential, you’d need to recognise that the
results are based on your interpretation of how to manage 2) By definition, TD Sequential requires a minimum of 22
the risk and profit taking inputs. price bars before it can generate a buy or sell signal subse-
quent to a completed TD Setup and TD Countdown,
TA: Presentations that we have heard on the Sequential whereas TD Combo only needs a minimum of 13 price
suggests that the profitability of trading Setups and bars to generate a completed TD Setup and TD
Countdowns lies not necessarily in the frequency of Countdown – so TD Combo is useful in determining
their success but rather in using them as a risk manage- prospective trend exhaustion points after an abrupt direc-
ment tool. In effect, the gains from when the Sequential tional move. Again, combining the indicators on multiple
works are much bigger than the losses from when it time frames and coupling them with TD D-Wave gives
fails. Do you go along with this? one an objective insight into the most opportune time to
use one rather than the other, particularly if the market has
JP: Yes, absolutely. Like I said, TD Sequential is by no means reached a projected TD D-Wave target.
the Holy Grail, but it does provide some acute risk / reward
trading opportunities, both in ranges and in the latter stages TA: What exit strategies do you use/recommend using
of a trend. When used over multiple time frames and in con- after entering a TD Sequential triggered trade?
junction with other TD indicators such as TD D-Wave, the
hit rate on successful trades based on TD Sequential can be JP: DeMark doesn’t discuss this in detail, so this is my per-
significantly improved. Both Tom and I are keen to stress that sonal interpretation;
the indicators are market timing tools rather than technical
analysis per se. Increasingly I find non-technically oriented 1) Wait for a fresh signal in the opposite direction
customers are recognising the added value the indicators pro-
vide in terms of improving the efficiency of trade entry and 2) Trade around prior TDST levels or
exit in conjunction with a fundamentally driven trade idea.
3) plot the distribution of signals generated by TD Sequential
TA: What, in your view, are the main weaknesses of the over time and try to determine the most that the market
Sequential Indicator? moves on average subsequent to a signal or prior to a pull-
back of at least x% - then use that as a take profit target,
JP: By definition, since TD Sequential is counter-trend so it regardless of whether there is a fresh signal in the oppo-
will have a tough time when markets are trending strongly in site direction or not.
one direction. However, that’s precisely why I stress the need
to evaluate each signal on a case by case basis and consider it TA: How has the use of DeMark changed over the past
in the context of the broader trend. One should always be few years? If it has increased, why do you think this is?
aware of what the indicator is saying on longer-term time
frames (so you know whether you are trading in-line with or JP: When I first heard about the DeMark indicators 14 years
against the broader trend), and note where the signal lies rel- ago, their use was limited to a relatively small number of peo-
ative to the current TD D-Wave count. That won’t complete- ple who were familiar with Tom and his work. The indicators
ly offset the risk of being stopped out in strong trends, were not available on the mainstream quote vendors as they
but it will certainly reduce the occurrence in a very objective are now (such as CQG, Thomson and Bloomberg). The
manner. introduction of the TD indicators onto Bloomberg about 6
TA: What are the main advantages of using the TD years ago was a tremendous boost as it meant the studies →
TA: Is your TA research mainly focused on using JP: One of the advantages of TDRS and the scanning func-
DeMark? tionality is that it enables one to follow a large number of
instruments and look for common macro themes among the
JP: I believe UBS Technical Strategy is unique in the sense signals generated. I don’t have a stock specific remit as my
that the group consists of product specialists, (based in primary focus is FX, fixed income and commodities, but it
London, Zurich, Stamford and Singapore), who are each was interesting to me that there was a confluence of cross-
experts in their respective areas. Consequently, each member market signals in a number of markets over the summer: a
of the group publishes research (and trade ideas) based sole- buy signal on the VIX at 16.30 on 15-May, a sell signal in US
ly on their individual methodology. My personal focus is 2 Year yields at 2.9206% on 10-June: a sell signal at 108.18 in
DeMark and the majority of the research that I produce is USDJPY on 13-June, a sell signal in the Nikkei at 14,354 on
based on that in addition to some historical statistical analy- 16-June: a sell signal in the Nasdaq Composite at 2,457.7 on
sis. That’s not to say I don’t believe in other forms of analy- 17-June, a buy signal in gold at 883.80 on 23-June and a sell
sis, quite the contrary – but I do believe there is a limit to the signal in AUDCHF at 1.0011 on 27-July.
number of things one can follow and this particular method-
EXPLOITING FRACTALS Dow Jones Industrial Average data, sug- exploiting these dependencies.
gest that the fractal nature of a time series
Moving averages and trading range break- leads to dependencies that technical Lento, Camillo,A Synthesis of Technical
out rules are the best at exploiting long- analysis should be able to identify and Analysis and Fractal Geometry - Evidence from
term dependencies in financial data, exploit to earn profits. Lento’s research the Dow Jones Industrial Average Components
according to Camillo Lento of Lakehead showed that moving averages and trading (September 4, 2008).
University. His results, based on analyzing range break-out rules were the best at
Volume Spikes
Further evidence that past price extremes stock price last achieved the price are reliably positive and, among small
influence investors' trading decisions has extreme, the smaller the firm, the higher investors, trades classified as buyer-initi-
emerged from a US-based research team. the individual investor interest in the ated are elevated.
They show that volume is strikingly high- stock, and the greater the ambiguity
er when the stock price crosses either the regarding valuation. Volume spikes when Huddart, Steven J., Lang, Mark H. and
upper or lower limit of its past trading price crosses either the upper or lower Yetman, Michelle,Volume and Price Patterns
range. This increase in volume is more limit of the past trading range, then grad- Around a Stock's 52-Week Highs and Lows:
New Momentum
pronounced the longer the time since the ually subsides. After either event, returns Theory and Evidence. Management Science.
Earnings
Surprises and
Market
Richard Harris of the University of low frequency momentum trading strate-
Exeter and Fatih Yilmaz of Bank of gy offers greater directional accuracy,
America have developed a momentum higher returns and Sharpe ratios and
Sentiment
trading strategy based on the low fre- lower maximum drawdown than tradi-
quency trend component of the spot tional moving average rules.
exchange rate. Using, alternately, kernel
regression and the high-pass filter of Harris, Richard D. F. and Yilmaz, Fatih,A
Hodrick and Prescott (1997), they recov- Momentum Trading Strategy Based on the Low
There is growing evidence in the finance er the non-linear trend in the monthly Frequency. Component of the Exchange
literature that investor sentiment affects exchange rate and use short-term Rate(August 2008). Xfi Centre For Financial
stock prices. Two researchers from New momentum in this to generate buy and & Investment Working Paper No. 08/04.
York University have examined whether sell signals. According to the authors, the
stock price reactions to earnings surprises
INTRA-MONTHLY MOMENTUM
and accruals vary systematically with the
level of investor sentiment. They find
PATTERNS
evidence that holding extreme good news
firms following pessimistic sentiment
periods earns significantly higher excess
returns than holding extreme good news
firms following optimistic sentiment peri- Are momentum strategies in the FX markets likely to work consistently through the
ods. Similarly, their results suggest that month? Not according to a team from the Universities of Exeter and Bristol. In their
holding low accrual firms following pes- paper, they document a very strong day-of-the-month effect in the performance of
simistic sentiment periods earns signifi- momentum strategies in the foreign exchange market. For example, for simple mov-
cantly higher excess returns than holding ing average based strategies the authors found that the Sharpe ratio is close to zero
low accrual firms following optimistic during the first half of the month until day 12, from when it starts to rise sharply,
sentiment periods. In addition, they doc- peaking initially around days 13-15, and then again at around days 20-22. The authors
ument that excess returns in the short show that a two-factor model employing conditional volatility and the volatility of
window around the preliminary earnings conditional volatility explains as much as 70 percent of the intra-month variation in
announcements for extreme good news the Sharpe ratio. They further show that the seasonality in volatility is in turn closely
firms are significantly higher during peri- linked to the pattern of US macroeconomic news announcements, which tend to be
ods of low sentiment than during periods clustered around certain days of the month.
of high sentiment. Overall, their results
indicate that investor sentiment influ- Harris, Richard D. F., Stoja, Evarist and Yilmaz, Fatih,Day-of-the-Month Effects in the
ences the source of excess returns from Performance of Momentum Trading Strategies in the Foreign Exchange Market(October 2008).
earnings-based trading strategies. Xfi Working Paper No. 08-05.
DEMARK
INDICATORS
Jason Perl is head of technical analysis at UBS in London, and is well known as one of the
financial market’s acknowledged experts on the indicators of Tom DeMark. DeMark himself
works closely with Steven Cohen at SAC Capital in the US, one of the world’s largest hedge
funds. This fact alone lends credence to his work and should persuade those who are highly
sceptical of his indicators to spend some time looking more closely at them.
Tom DeMark is always keen to stress that his indicators are more a market timing technique
rather than pure technical analysis. Either way, while DeMark does have many loyal followers,
evidence suggests that the indicators are still of minority interest among the trading and invest-
ment community. However, their profile has increased in recent years and this book meets the
demand for those wishing to learn more.
DeMark indicators are potentially a difficult technique to describe in writing. While they are
not especially complex to understand, they are more mathematical in nature than many tech-
nical indicators and as such, are better understood by looking at real examples. Because of this,
it is important that any book on the subject is clearly written.
By Jason Perl
Much of Perl’s book focuses on the TD Sequential indicator, the most popular and widely
Published by
Bloomberg Press used of all the DeMark range. This is a counter-trend signal generator that looks to capture
208 pages points of market exhaustion and reversal – both in uptrends and downtrends. Its popularity is
ISBN: 978-1-57660-314-7 probably down to the clarity of the signals it generates and the lack of active price analysis
$29.95 required by the user: the software generates the buy and sell signals – the so called Setup 9s
and Coundown 13s - and sets the stops. All the trader needs to do is determine his exit.
Perl describes in easy to follow detail how the Setup and Countdown work along with trad-
ing tips and numerous examples. He also augments each chapter with a FAQ section that
addresses some of the points that are often brought up about the indicators. These include,
for example, why the parameters 9 and 13 are used in the TD Sequential. While his answers to
some of these points, including the backtesting of the indicators, may not satisfy everybody,
he makes no attempt to shirk some of the more difficult questions usually posed about the
indicators.
However, there is a lot more to DeMark than the TD Sequential. Tom DeMark has his own
interpretation for many traditional technical analysis techniques such as moving averages and
trendlines. These are well worth further investigation as they offer a new approach to tradition-
al techniques that often suffer from subjectivity in their application. Perl also covers the TD
Combo, the TD D-Wave, TD Lines, TD Retracements, Trends, Oscillators and Waldos.
Tom DeMark’s own book on his indicators, “New Market Timing Techniques”, published in
1997, has been criticised by some as difficult to read and understand. If this is the case then
Perl’s book is a well written and essential antidote to this. In addition, Bloomberg’s new range
of technical analysis books are well designed and crucially, appear to have benefited from care-
ful editing, something that many such books often lack. If you are looking for DeMark enlight-
enment, or simply a fresh way to analyse price action, then this is the book to get.
A ll of the above books are available from the Global Investor bookshop at a discount. Please call +44
(0)1730 233870 and quote "The Technical A nalyst magazine".
DEMARK INDICATORS
• Research The STA Journal publishes research papers on TA techniques and approaches
• Meetings Provide members the opportunity to discuss technical approaches and markets
• Representation The STA lobbies on behalf of analysts with data vendors, exchanges and regulators.
The STA represents the UK at the International Federation of Technical Analysts (IFTA)
• Accreditation The STA Diploma Exam is internationally recognised as a professional level qualification
in Technical Analysis
the STA Diploma exam, visit our website at: www.sta-uk.org or call
s Ultra fast scanning and alerting s Report writer, logos and notes