Chart of the Week – March 21, 2004
Brett N. Steenbarger, Ph.D.
www.brettsteenbarger.com
A turning point in my personal trading career occurred when I began to research the idea of “trendiness”: the market’s tendency to behave in a trending fashion. Thinking through the various ingredients of trending—price direction, momentum, acceleration, volatility, relative strength, etc.—I arrived at a composite measure that captured this elusive idea. I called it the Power Measure, and it has been my chief measure of the market’s short-term trending behavior ever since.
In the last month, several opportunities have arisen for me in my career as a psychologist that have been too good to pass up. The downside of these opportunities is that they have been so time-demanding that I am no longer able to maintain my daily weblog and participate in intraday trading. Unwilling to completely abandon the markets, however, I turned my attention to an intermediate-term version of the Power Measure that might anchor a form of swing trading that does not require close attention to the screen within the trading day.
What I have come up with so far is an Intermediate-Term Power Measure that is constructed similarly to the original, short-term version, but utilizes weekly instead of intraday data. For purposes of easy interpretation, I built the index so that it would vary between extremes of +100 (maximum upside trendiness) and –100 (maximum downside trendiness), with levels near zero indicating a neutral, non-trending market.
Below is a recent chart of the Intermediate-Term Power Measure. Note that we currently sit at a level that has generally been associated with intermediate-term market bottoms. In general, levels above +50 that have begun to turn down have alerted us to tops in the market. Levels below –50 that have begun to turn up have put us on notice for market lows. When levels are very close to +100 or –100—indicating extreme trending to the upside or downside—it is not at all unusual to see higher or lower prices in the near-term prior to any reversal. Thus, the market weakness late this week after we hit an extreme negative trend value the prior week was not at all out of character for the market.
A few applications of the Intermediate Power Measure (IPM) come to mind. First off, it provides a nice working definition of a long-term bull and bear market. A long-term bull market is one where successive peaks and valleys in the IPM occur at higher price levels. Conversely, a long-term bear market is one in which successive extreme readings in the IPM occur at lower price levels. By that definition, there is little doubt that we remain in a bull market despite the recent correction.
A second application involves the selection of trading vehicles. The data utilized for the IPM are available for any tradable instrument, including individual equities, sector indices, ETFs, and futures contracts. It is conceivable that we could create trendiness measures across a universe of trading alternatives and allocate funds to those that display the best trending qualities. This is my next major research project, as it holds the promise of maximizing returns per trade.
Finally, it seems to me that using the original Power Measure in conjunction with the IPM could identify markets that are trending across two time frames. This would aid in market timing. Hypothetically, a buy signal would be given when the IPM is below –50 and the Power Measure turns bullish. A sell signal would occur when the IPM is above +50 and the Power Measure turns bearish. (Actually, in the system I’m developing, the signals for identifying market highs and lows are not symmetrical, as markets usually take a longer time to form tops than bottoms). Particularly good trading periods would occur when the trend readings are in the same direction and expanding across both the Power Measure and the IPM.
I will be following the IPM in coming weblog entries to see if it lives up to its potential.
Brett N. Steenbarger, Ph.D. is Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY. He is also an active trader and writes occasional feature articles on market psychology for MSN’s Money site (www.moneycentral.com). The author of The Psychology of Trading (Wiley; January, 2003), Dr. Steenbarger has published over 50 peer-reviewed articles and book chapters on short-term approaches to behavioral change. His new, co-edited book The Art and Science of Brief Therapy (American Psychiatric Press) is due for publication during the first half of 2004. Many of Dr. Steenbarger’s articles and trading strategies are archived on his website, www.brettsteenbarger.com.