GGlobal Sellobal Selll OOffff - The Technical Analyst Perl of UBS talks about DeMark indicators...

Octo

be

r2

00

8

.technicalanalyst.co.ukwwwThe publication for trading and investment professionals

Interview TechniquesTrading the futures markets

with Howe’s Limit Rule

Special FeatureChris Charlton of

Centa AM discussescurrency asset management

Jason Perl of UBS talksabout DeMark indicators

Global Sell OffGlobal Sell OffTechnical levels give direction to marketsTechnical levels give direction to markets

© 2008 Global Markets Media Limited. All rights reserved. Neither this publication nor any part of it may bereproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical,photocopying, recording or otherwise, without the prior permission of Global Markets Media Limited. While thepublisher believes that all information contained in this publication was correct at the time of going to press, theycannot accept liability for any errors or omissions that may appear or loss suffered directly or indirectly by anyreader as a result of any advertisement, editorial, photographs or other material published in The TechnicalAnalyst. No statement in this publication is to be considered as a recommendation or solicitation to buy or sellsecurities or to provide investment, tax or legal advice. Readers should be aware that this publication is notintended to replace the need to obtain professional advice in relation to any topic discussed.

CONTENTS 1 FEATURES

2008: presidential electioncycle update

Dimitri Speck of Seasonal Charts looks again atthe cycle and how stock markets may move as

the election day approaches

US stocks: 1973/74 revisitedWe summarise Tom DeMark’s recent talk at

Bloomberg’s offices in London and the views hegave on the markets

InterviewWe speak to Jason Perl, head of technical

analysis at UBS about how he uses DeMarkindicators in his client research

OCTOBER

>08

>18

>41

>

> >

WELCOMEJust when you thought things couldn’t get any worseHwith sentiment being so

negative at the moment for all markets, not just stocks, it is perhaps time to take acontrary view, as advocated by Anthony Bolton. Technical analysis has much tooffer in this area and the indicators of Tom DeMark work specifically as a coun-

tertrend signal generator for both the short and long term. In this issue we summa-rize DeMark’s recent talk in London, review a new book on his indicators, and look

at the D-Wave, a DeMark take on Elliott Wave formations.

We hope you enjoy this issue of the magazine

Matthew Clements, Editor

October 2008 THE TECHNICAL ANALYST 1

Use TradeStation Simulator to test your strategies in live market trading — without risking a cent!TradeStation’s new trading Simulator brings an even greater level of confidence to your trading, allowing you to harness the power of TradeStation’s award-winning platform and test your trading ideas in real time in today’s markets—without risking your own money.

No matter which markets you trade or would like to begin trading—equities, options, futures or forex—Simulator allows you to see how your ideas would perform under “live” market conditions—with no financial risk whatsoever. Simulator is a great way to get live, hands-on experience with all the advanced features of TradeStation, as well as to experiment with trading strategies and ideas in markets you may not have traded before, such as forex.

Design, Test and Optimize Your Trading StrategiesCustomize your own trading strategies and back-test them against decades of historical intraday market data. Analyze your performance via TradeStation’s Strategy Performance Report. You can then optimize your strategy based upon the various inputs you have defined, and then view these results via our Strategy Optimization Report.

Monitor and Execute Trades in Real TimeTradeStation is continuously monitoring the market tick-by-tick according to your defined rules. Reacting to your signals is a critical step in the trading process. Reduce latency and unnecessary third-party applications by automating execution via TradeStation Securities. Our DVP and Give-Up services allow you to maintain your current custodial relationship while taking advantage of TradeStation’s unique technology.

Your Money. Your Rules.Create, back-test and optimize your trading strategies.

TradeStation®

Introduced by TradeStation Europe Limited

RATED BEST FOR:Frequent TradersOptions TradersInternational Traders

Trading TechnologyTrade Experience

“BARRON’S new overall champ...”

BEST Stock Trading SystemBEST Options Trading SystemBEST Options Analysis SoftwareBEST Futures Trading SystemBEST Futures Brokerage

BESTProfessional Platform

BESTInstitutional Platform

4 YEARS IN A ROW 2005-2008 6 YEARS IN A ROW 2003-2008 MARCH 2008

radeStation TbyIntroduced aderradeTTr

LimitedEurope Station

®nn®iontaattSStde ®

ack-test andCreate, b

our MoneyYYour Moneyoptimize your tradck-test and

our Rules.. YYour Rules.oneying strategies.mize your trad

Rules.ng strategies.

Optimization Report.

can then optimize your strategy based upon the various inputs radeStation’s Strategy Pperformance via TTradeStation’s Strategy P

against decades of historical intraday market data. Analyze your Customize your own trading strategies and back

est and Optimize YDesign, TTest and Optimize Y

ur strategy based upon the various inputs erformance Report. YeStation’s Strategy P

istorical intraday market data. Analyze your -test them trading strategies and back

rading Strategiesour TOptimize YYour T

advantage of Tyou to maintain your current custodial relationship while taking

radeStation Securities. Our Dvia TTradeStation Securities. Our Dunnecessary third-party applications by automating execution is a critical step in the trading process. Reduce latency and

radeStation is continuously monitoring the market tickTrMonitor and Execute T

ous inputs ou e Report. YYou

nalyze your them trategies

radeStation’s unique technologyTn your current custodial relationship while taking

VP and Give-Up services allow n Securities. Our Dhird-party applications by automating execution p in the trading process. Reduce latency and

continuously monitoring the market tickrades in Real Td Execute T

.yhip while taking Up services allow ating execution

e latency and

--byarket tickimeT

ptions OESTBtockSESTB

ystemSrading Tns ystemSrading T

PrEBrofessional PlatformEST

radersTrequent F:RTED BEST FORAATED BEST FO

echnologyTTechnologyrading T

utureFESTButureFESTBptions OESTBp

4 YEARS IN A ROW

es BrokerageystemSrading TesoftwareSnalysis Ans

yg

InEB

2005-2008W 6 YEARS IN A ROW

“BARRON’S new overall champ...”stitutional PlatformEST

2003-2008A ROW

new overall champ...”

radersTInternational radersTrptions O

MARCH 2008

xperienceErade T

Editor: Matthew ClementsManaging Editor: Jim BissConsultant Editor: Trevor NeilAdvertising & subscriptions:Louiza CharalambousMarketing: Vanessa GreenEvents: Adam CooleDesign & Production:Stuart Field

The Technical Analyst is published by

Global Markets Media LtdJeffries House1-5 Jeffries PassageGuildfordGU1 4APUK

Tel: +44 (0)1483 573150Web: www.technicalanalyst.co.ukEmail: [email protected]

SUBSCRIPTIONS

Subscription rates (6 issues)UK: £160 per annumRest of world: £185 per annumElectronic pdf: £49 per annumFor information, please contact:[email protected]

ADVERTISING

For information, please contact:[email protected]

PRODUCTION

Art, design and typesetting byStuart Field.Printed by Goodman Baylis

ISSN(1742-8718)

MARKET VIEWSFTSE 100: major low at 3277AUS/USD: outlook to the downsideUS stocks: 1973/74 revisited

SPECIAL FEATURECurrency Asset Management

TECHNIQUESHowe’s Limit Rule2008: Presidential Election Cycle UpdateObservations on Lunar Phase & US PanicsStumbling on Value InvestingVolatility Trading using the VIXTD-Wave - A rule based approach to Elliott Wave analysisSizing up a Superpower: a Socionomic Study of Russia

INTERVIEWJason Perl, UBS Investment Bank

RESEARCH UPDATE

BOOK REVIEWDeMark Indicators

TRAINING DIARY

040608

10

16182225283234

41

45

47

48

CONTENTS 2 REGULARS>


16 47

Market Views

4 THE TECHNICAL ANALYST October 2008

Sandy Jadeja

FTSE 100:major lowat 3277By Sandy Jadeja

Support levelsThe UK FTSE 100 index has already lost 37% from the July2007 high of 6754. A bear market is considered if a declineof 20% or more is in place. Clearly we have surpassed thisand sentiment figures are showing that we are already in abear market. One should remember that the rally we sawfrom March 2003 reached a high of +106% and so thedecline can be counted as a retracement, albeit a major one.Unless we surpass 3277 on the FTSE - which equates to theneckline of a double top formation (see Figure 1) - the cur-rent move is still classified as a correction.

Technically the key support levels are 4605 and 4020 ofwhich the latter should hold the index up. If we fail to stayabove 4020 this would have serious implications for theindex as the next support level would be below the major lowcoming in at 3277. Although this sounds unrealistic weshould remember that when oil had been trading at $37 dur-ing 2003, expecting the commodity to reach a gain of morethan 400% also seemed unrealistic. In the current environ-ment anything is possible.Historically we know that the months of September and

October are disastrous for the stock market and this year isno different. If we are to see a late rally then a break above5090 is required to turn the downward trend to an upwardtrend, at least in the short term for the FTSE 100.

Buying opportunity?Some analysts feel that the market is cheap and ripe for theinvestor to get in and pick up bargains. History has taught usthat trying to catch a falling knife is dangerous and shouldnot be attempted. My view is that a significant reversal isrequired where we see at least a higher close on a weekly price

bar before attempting to buy a particular stock. Many havetried to capture bargains in the financial stocks only to havefound that the pain of losing can be excruciating as it hasbeen in this particular sector.If we take seasonality and cycles into consideration, the

year 2007 was already flagged as being a potential high. Weknow that years ending with sevens tend to be marked bymarket highs and years ending with twos offer market lows.This suggests that we are likely to be in a bear market until2012, with a strong corrective rally during 2009. The majorindices had also reach Fibonacci Price Extensions and ElliottWave traders had seen a major five wave pattern pointing toa market fall.

Turning pointsIn the current market if one were to use oscillators and lag-ging indicators, such as moving averages, one would find thatthese tools would be rendered useless. The market has tech-nically been oversold for three months now and oscillatorstend to perform poorly in trending markets. For short termforecasts a break above the weekly high is far more superiorfor the bulls and vice versa for the bears. Price tools havealways been more powerful than indicators which are simplyderivatives of price anyway.Analysing open interest figures has shown that there have

clearly been more sellers than buyers recently and volume onthe downside has been three times greater than the upside onaverage. This is typical in downtrends once panic kicks in. Westill do not have a full out bearish sentiment at the extremewhich is required to see a major reversal. Time analysis pointsto October 14-17 or the last week of October as potentialturning points. We also have mid November as an extremecycle date. Combining timing with classical technical analysisshould prove useful for technical traders.Once we have a firm low in place this would have complet-

ed a “phase one” which should be followed by “phase two”a corrective rally. This should take us into 2009 and then thetechnical picture shows that another leg down could takeplace as the “phase three” which could be very devastating.Analysts such as Bob Prechter and Albert Edwards also havecome up with similar conclusions that the decline is not yetover. It is possible that we could still see a further 20%shaved off current levels in the next phase.

Sandy Jadeja is chief market strategist at ODL Markets

The financial markets have been hit by a tornado of selling which has takenmajor indices to new five year lows. The question on investors and tradersminds is how bad can this really get?


Market Views

Figure 1

AUS/USD:OUTLOOK TO THE DOWNSIDEBy Mohammed Isah

AUD/USD came in strongly off its recent low at 0.7802 toclose higher at 0.8362 recently. This is coming on the back of acollapse off its YTD high at 0.9851 in mid-July’08 (Figure 1).

Before the pair’s recent sell off, AUD/USD had enjoyed anuptrend dating back to Sep 2001 after a bearish trend struc-ture that began in Dec 1996 and bottomed at 0.4825/51 inApril/Sep 2001. While pullbacks off its Feb 2004 high at0.8005 were seen, and subsequent retests failed at the 0.7773level in Nov 2004 and the 0.7872 level in Mar 2005, priceconsolidation that ensued developed into an ascending trian-

gle (a continuation chart pattern) which ultimately broke outto the upside in Mar 2007.

Target of 0.9230 reachedHaving decisively resolved to the upside, two technical issueswere triggered: the first being the resumption of its longerterm uptrend started in Sep 2001, and the second relating tomeeting its ascending triangle pattern price target at 0.9230established by measuring the width of the pattern and pro-jecting it from the breakout point. Although setbacksthrough the breakout point and the 0.8005 level occurred inAug 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 achieveits breakout target at 0.9230. With the pattern of higher highsand higher lows established, AUD/USD rallied to a high of0.9851 in mid-July 2008 after a two-month corrective pull-back was seen in Nov/Dec2007.

Overbought signalsWith clear overbought signals displayed on both the weeklyand monthly charts (though parity status was looming fol-lowing AUDUSD’s attainment of its highest price since1983), the collapse off the mentioned high was technicallyexpected though the sell off was fast and deeper than envis-aged.Although the parabolic declines tested the 0.8005/0.7802

levels and turned back above there while key supports at the0.9328 (June 2008 low), 0.8954 (Mar 2008 low) and 0.8512(Jan 2008 low) levels remain unbroken, the medium termoutlook continues to point lower implying its bounce off the0.8005/0.7802 area is corrective of its weakness started at0.9851. Our medium term target resides at the 0.7676 level,its Aug 2007 low and its 100 monthly EMA at 0.7570.On the other hand, as indicated above, a combination of

oversold conditions, parabolic declines, the formation of →→

Figure 1: Weekly Chart Source: ProRealTime

Reversal ahead of the 0.8005/0.7991 zone to herald recovery

Market Views


two hammers, and the provision of support by the0.8005/0.7991 zone have triggered the present recoveryhigher. This corrective recovery based on its foundationshould target the 0.8512 level on a follow-through to theupside from the mentioned hammers with possible furtherstrength to the 0.8954 level.On the whole, as long as the losses of the earlier men-

tioned key support levels and bearish monthly and quarterlystudies remain in place, AUDUSD’s broader (medium term)outlook remains to the downside.

Market Views

Figure 2: Monthly Chart Source: ProRealTime

Mohammed Isah is a TechnicalStrategist and Head of Research atFXTechstrategy.com, a technical

research website. He was also a for-mer market analyst and head ofresearch at Fxinstructor LLC.FXTechstrategy.com offers to itsclient’s daily and weekly technical

commentaries on currencies and com-modities. Mohammed can be reached

at [email protected].


Market Views


Tom DeMark

US STOCKS:1973/74 REVISITED

Monday October 6th saw Tom DeMark give another of hisannual talks at the London offices of Bloomberg, part of awhistle stop tour of the major European financial centres.These have proved to be very popular in the past but dramat-ic events in the markets on the day threatened to dampenturnout. In the end, DeMark need not have worried: atten-dance was impressive with close to 200 hearing him give hisviews on the markets and discuss his indicators.

1973 and todayHis talk centred on the similarity between the markets in1973/74 and today. By overlaying charts from the two peri-ods on top of each other, DeMark dramatically highlightedthe similarity in price patterns and volatility levels over oneyear periods for US stocks and oil. Prices today are likely togo on to continue this correlation next year. This view wasalso supported by a wide range of technical factors using hisown indicators and Fibonacci retracements. In the short tomedium term a stock market rebound will present a goodbuying opportunity. After that, the outlook becomes muchdarker.

DeMark indicators Using the TD Sequential, DeMark showed that the S&P500is at a Countdown “13” – a key indicator of market exhaus-tion and a potential major price turn. This is also supportedby his measure of market volatility, or fear gauge, the VXO.This has proved to be a reliable indicator for market lowswhenever it has spiked about the 50 level. This was the casein 2001 after September 11 and is happening again thismonth. Furthermore, this is typically followed by a rally of20% or so before further unravelling takes place. As such, thelow of w/c 6th October will see the start of a rally to the endof the year, but the FTSE 100 will then resume its decline toa low of 4150 between March and October 2009. This targetis based on a 61.8% Fibonacci retracement from the market

all-time high of 6700. However, DeMark is not a charting purist. His rational for

the fall in US stocks next year is based on political-economicfactors: namely, Barack Obama winning presidential electionthis year. Once he takes office in the White House next year,his administration will be perceived as being anti business andpro higher taxation.

FibonacciDeMark also highlighted his faith in Fibonacci retracements.Indeed, many of the parameters he uses in his indicators arebased on the Fibonacci sequence. He drew particular atten-tion to levels to be expected from a market top based on theclassic 61.8% retracement. For example, oil = $90 (from $144x 61.8% - this retracement is also what happened in 1973/4).From this retracement, DeMark sees a price target for theS&P500 of 960 between March and October next year.


Market Views

“THE LOW OF W/C 6THOCTOBER WILL SEE THE STARTOF A RALLY TO THE END OF THEYEAR, BUT THE FTSE 100 WILLTHEN RESUME ITS DECLINE TOA LOW OF 4150 BETWEEN

MARCH AND OCTOBER 2009”.

TOM DEMARK

A summary of Tom DeMark’s recent talk in London and his views on the markets

Special Feature



Special Feature

CURRENCY ASSETMANAGEMENTWe talk to Chris Charlton of Centa Asset Management about his multi-manager investment approach tothe foreign exchange markets

Chris Charlton has been actively involved in the inter-national foreign exchange markets for over 30 years,starting his career at J.Henry Schroder Wagg in 1974.At Merrill Lynch in the eighties he ran the London-based trading desk for large institutional investors, andlater at Security Pacific bank he was responsible foradvising European central banks. In the mid-nineties heran the treasury sales desk at Credit Lyonnais/BfG Bankin Frankfurt, and his last post in FX was as treasurer ofBankhaus Wölburn, a private bank in Hamburg. He hasbeen running his own business since 2002 focusing oncurrency asset management and consultancy services.

6-8 November 2008 Le Meridien EtoileParis, France

Saturday 8 November

Tony Plummer: the logic of non- rational behaviour in financial markets

Claude Mattern (BNP): strength and limit of technical analysis : market action, interpretation and price anticipation

Private visit of the museum and gala dinner at the Louvre

Conference Includes

Full program on www.iftaparis2008.com

Thursday 6 November

Walkabout, traditional IFTA round tables meeting

Chistopher Neely (Fed de St Louis): relationship between order flow and macroeconomic announcements on the forex market

2009 outlook by a panel of strategists

Dinner cruise on the Seine

Friday 7 November

Prof. Carol Osler (Brandeis University): analysis of stop-loss orders distribution and its relation to market volatility

Yasmina Hasanhodzic (MIT): demystifying and automating technical analysis and hedge-fund strategies

Yannick Daniel (Société Générale): combining behavioural financial with fundamental inputs in a hedge fund

Maxime Viémont (BNP): hybrid trend-following strategies

Registration and accomodation by phone +33 1 53 85 82 82and on: www.iftaparis2008.com

Delegate fee: � 900� € + VAT (IFTA member)Delegate fee: � 1200 �€ + VAT (non-IFTA member)


by a panel of strategists2009 outlook

ex market the foroeconomic announcements on macr

elationship between orrChistopher Neely (Fed de St Louis):

tables meeting

combining behavioural financial with annick Daniel (Société Générale): YYannick Daniel (Société Générale):

strategies technical analysis and hedge-fund demystifying and automating

asmina Hasanhodzic (MIT): YYasmina Hasanhodzic (MIT):

volatility distribution and its ranalysis of stop-loss or


by a panel of strategists

oeconomic announcements on der flow and elationship between or

Chistopher Neely (Fed de St Louis):

combining behavioural financial with annick Daniel (Société Générale):

strategies technical analysis and hedge-fund demystifying and automating

asmina Hasanhodzic (MIT):

volatility elation to market distribution and its r

ders analysis of stop-loss or

combining behavioural financial with annick Daniel (Société Générale):

technical analysis and hedge-fund

elation to market

dinner at the LouvrePrivate visit of the museum and gala

anticipation etation and price action, interpr

limit of technical analysis : market Claude Mattern (BNP):

marketsrational behaviour in financial

dinner at the LouvrePrivate visit of the museum and gala

etation and price limit of technical analysis : market

ength and strClaude Mattern (BNP):

rational behaviour in financial

following strategiesMaxime V

fundamental inputs in a hedge fundcombining behavioural financial with

ogram on wwwFull pr

following strategiesend-hybrid triémont (BNP): Maxime V


.iftaparis2008.comogram on www

end-


.iftaparis2008.com

TA: What is the difference between a FX multi-managerand fund of funds approach?

CC: From the concept of modern portfolio theory, very lit-tle. Both look to reduce risk by diversification. The differencelies in the scope of investment opportunities and the struc-ture of the investment vehicle. There are a vast number ofcurrency managers available (CTAs) to choose from whilstthe number of currency funds is limited. As the nameimplies, fund of fund managers can only invest in funds andtherefore the investment choice is limited. The difference in structure is more complex but there are

a few important points. In many cases a fund of funds willnot be able to know its real exposure and results until all thedifferent funds have reported their own. Liquidity can be aproblem and there can be restrictions on entry and exit. Inour case - the multi-manager route - we have daily liquidity sowe can exit or change the portfolio on a daily basis as well asour investors. We have daily reporting so we know exactlywhat each of our managers is doing and we can see our totalcurrency exposure. Another point is that a fund of funds maycharge extra fees in that they often charge an extra manage-ment and performance fee on top of the individual fund fees.This can add up. At Centa, we do not charge any perform-ance fee.

TA: What are the advantages of investing in a multi-manager fund rather than a single manager one?

CC: This is classic portfolio theory; diversification reducesspecific risk. By investing in a number of managers with dif-ferent strategies, one can reduce the risk of the overall port-folio down to a certain point whilst still expecting to achievea satisfactory return.

TA: Whose money do you manage and how much doyou have under management?

CC: We have designed the product to be eligible for bothinstitutional and retail investors. There are different ways ofreporting AUM. We launched the product in January and atthe present time we have $64 million under management.

TA: Can you explain the process you go through inselecting your managers?

CC: We select our managers via the Deutsche Bank platformcalled FXSelect platform and it is a perfect solution for aninvestor who wishes to invest in a single manager or an indexof his choice. One example is that the investor has a singlecontract with Deutsche bank rather than having individualones with each manager. We have decided that around ten managers is a suitable

number for our programme. We have a universe of about 100

managers that we look at and search for ones that meet ourcriteria. We start using basis quantitative analysis andprogress through various stages of more complex due-dili-gence until we come out with a core number of managersthat suit our expectations.To begin with we look at some traditional statistical analy-

sis such as absolute returns, maximum drawdown, Sharpeand Sortino ratios. We then look at the managers’ tradingstrategies and conduct look-back analysis to check theirrobustness. An important part of this is the comparisonanalysis with our own in-house benchmark portfolios. Wealso put great emphasis on qualitative analysis and this is thenext step: we look at factors such as staff turnover, risk con-trols and back up, administration, office location and others. Once we have arrived at a core number of managers we

then conduct personal visits. It is our intention to get underthe skin of the managers and really understand their plansand targets, their fears and anxieties, their daily routines andpressures etc. We are specialists in behavioural analysis andthis plays a large part in our due-diligence.Finally we come up with a simple question, Can we trust

these guys with our money going forward? As I have said, for the programme we have come to the

conclusion that around ten managers is the optimal numberto provide a variety of trading strategies that will perform inmost market conditions and provide us with steady growthwithin an acceptable risk profile.

TA: What’s different about your selection process com-pared with other multi managers?

CC: We put a lot of emphasis on the behavioural aspect ofmanagers not just the traditional statistical returns. We havefive members in our asset allocation committee all with overthirty year’s individual experience in the markets. I believethat combined we are in a better position to judge managersand their strategies. That is our advantage.

TA: How do you decide on the weightings that you giveeach manager? Is it purely performance related?

CC: Preferably we like to have a relatively even distributionbut there are cases where we will have lower or higher weight-ings. If a manager has a high volatility then we will be biasedto have a lower weighting despite the potentially higherreturns and vice-versa. In other words we are always lookingat ways of reducing risk and volatility rather than just produc-ing high returns. We will also look at the strategies: many managers will be

active in all markets which means we have to look at theirindividual exposures to certain currencies. We have our over-all limits to different currencies within the total portfolio andthis will then affect the weightings of the individual man-agers. →→


Special Feature

TA: Why do you think there are so few fund of fund cur-rency managers?

CC: This is because it is only relatively recently that curren-cies became a recognised asset class and therefore there areonly a limited number of currency funds. I think you have todifferentiate between currency funds and currency managers(CTA programmes) of which there are many. We have creat-ed a multi-manager programme that can be integrated into afund or another structured product.

TA: What returns has the multi-manager programmeseen in the past 12 months. What is the Sharpe ratio?

CC: We launched the programme in the middle of Januarythis year and we are currently up 4.8%. I would like to stressthat the aim of our programme is to produce an annualreturn of 5% over Libor. We are not expecting to see 20%returns, and more importantly, we do not expect to see 20%drawdowns. Looking back to 2004, the present portfolio hasa Sharpe ratio of 1.6 and has not had a monthly drawdownexceeding 2%.

TA: What performance measures do you use to assess amanager?

CC: For performance we look at traditional quantitativemeasures such as Sharpe and Sortino ratios, drawdowns andvolatility. We also use a series of sentiment strategy bench-marks to assess the success of manager strategies on amonthly basis. For example these can be based on yield, trendor volatility.

TA: You mention on your site that you look at the strat-egy of a manager and assess if this is likely to continueinto the future. How do you assess whether a strategy islikely to perform well in the future?

CC: If a manager has had a good year of returns it is not thecase at all that this will necessarily continue. A pure trend fol-lower will under-perform in a consolidation market and vice-versa. The carry-trade was a simple bet in 2006 and the firsthalf of 2007. Now it is far more complex. The main pointhere is to look at the adaptability of the manager and howmuch experience he has had in the market. Managers mostlycan be put into two classes: fundamental or systematic. Eitherway we like to see that the managers are dynamic in theirapproach to different market conditions. This is very impor-tant.

TA: Can you give us some examples of the type ofstrategies employed by the managers?

CC: Firstly we can differentiate between what currencies theyare trading. Let’s categorise them into G10 and Emerging

Markets. Then we can look at their strategies: fundamental orsystematic, short-term or long-term. Many managers buildcomplex models to assess yield differentials, economic funda-mentals and so-on. Many use technical analysis. As you cansee there are many variations.

TA: How do you assess the risk associated with eachstrategy?

CC: This is an important point and we look closely at the riskprofile of each strategy. Most managers sets the risk level oftheir strategies by allocating a risk budget and setting stoplosses to ensure that the budget is not exceeded. Thus the riskis not simply associated with a particular strategy, but alsowith its implementation.

TA: Are you looking for strategies that are uncorrelatedwith other asset classes, strategies and FX rates?

CC: Generally we can say that currency returns are uncorre-lated to the returns of other traditional asset classes such asequities and bonds, but there are many situations where thestrategies may be correlated. An obvious example is the cor-relation between the yen-carry trade and the equity marketperformance, at least until recently.We are not concerned whether the strategy is correlated to

other markets or not, rather that the strategy itself is robust,has adequate risk parameters, and that we can feel confidentthat we are protected should events change rapidly and thecorrelation unravels.

TA: What strategies tend to perform best in periods ofhigh volatility and/or market turmoil?

CC: Short-term strategies tend to perform better in theseenvironments. The reason simply is that they have muchshorter profit and loss horizons. Although one can argue thatthey could produce a series of small losses, the danger oflarge losses is reduced. This is typical of models that havemore medium-term horizons and do not react quicklyenough to sharp moves in price or volatility. Therefore ourportfolio contains some short-term trading managers.

TA: What strategies and currencies have performed bestover the past 5 years or so?

CC: Certainly the carry-trade was the best performer, so longhigh-yielders and short the yen and CHF. In the last two yearsthe US dollar gained prominence as a carry-trade currency asUS rates fell. This is being reversed now. It seems that themarkets are not so straightforward anymore and the bestexample of this is when one looks at many managers whohave “hockey-stick” performance records. In that I meanmany years of positive growth and then a sideways move-ment over the last few years.

Special Feature


Berkeley Futures Ltd announce the launch ofMake Automated Trading Easy with

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 [email protected] or see our website, www.bfl.co.uk

gy simulation toolPosition management on signals

vanced chartingrt trade indicatorsrt order entry

rs visible in charts

Berkeley res Ltd is authorised and regulated by the rvices 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.

Berkeley Futures Limited has been offering dealing services in Derivatives to institutions and individuals since 1986.

We deal in Futures, Options, CFDs, Bullion, Forex and Equities for Individuals, Corporates, Hedge Funds, Introducing Brokers and SIPPs.

Berkeley, in conjunction with the Group, will be exhibiting Berkeley IQ-Trader at the Automated Trading 2008 conference, London 15th October.

ket ordersTrendline stops

ryagement

Paper trading

Trading signals from indicators gy backtesting

gy optimisationr-product spreading

gy scripting tool

J avile Row

DefinitionRobert Howe, a market technician and analyst, first offeredhis rule in 1977. Howe's Limit Rule simply suggests that:

A price at the limit of a tradable daily range, once reached, becomesan objective which the market will again test and ultimately exceed,at least briefly and usually sooner rather than later.

Why should this be so? A primary function of any marketis to explore and discover value. A market that is artificiallyinterrupted (when limit up) in its pursuit of current value isunsatisfied and leaves unanswered questions, such as how farand how urgently the market would continue searching.Unlike objectives derived from chart formations and mathe-matical formulae which might approximate a target range,HLR identifies precise price targets.

For instance, if a market trades at a "limit up" price then:

• Short-term traders may more confidently buy into anypullback (whether intraday or during subsequent tradingdays)

• Traders already long may be encouraged to maintain theirpositions

• Prospective short-sellers may be discouraged from takingimmediate action and wait until the price level is exceeded

Trading strategy By acting on the principles of HLR, each of the above wouldexpect any price decline to be small, unless and until the limitprice is exceeded by at least one tick. However, if after a pro-longed trend a limit price is exceeded only briefly and tenta-tively, a failure leading to a reversal may be imminent asthe market exhibits exhaustion.

Howe’s Limit Rule isn’t an indicator as such; it is moreof a trading strategy. Nevertheless, the “rule” does provide trading signals of a kind that can be used infutures markets where there are limits on permissibledaily price ranges.

→→

Howe’s LimitRule

Indicator Focus:


Techniques

As a corollary, an unexpected limit move in the oppositedirection of the prevailing trend can be an early warning of atrend reversal (as everyone changes their minds at the sametime). Finally, an abrupt limit move out of a accumulative ordistributive congestion phase can signal the beginning of apowerful new trend (as everyone tries to go through the samedoor at the same time).On the rare occasion when a lead contract leaves a traded

limit price "hanging" (not exceeded prior to its expiration),that limit price is carried over as a future objective for subse-quent lead contracts. As such, it can become a magnet forintermediate- or long-term trend exhaustion. In other words,the prevailing trend may be maintained and/or a new trendsuppressed from beginning until that "hanging" limit isexceeded, often creating a double top or double bottom.This happens because the lead contract is most cash-con-

nected and used on weekly/monthly charts. Hanging limits

on nearby contracts often become significant sup-port/resistance points on weekly/monthly charts. Limits lefthanging in deferred contracts are specific to them only andusually become irrelevant at expiration.

Exceeding the limit According to the Moore Research Centre (MRCI), of key his-torical significance are the first and third days immediatelyfollowing a trade at a limit price. In a majority of those mar-kets a limit traded price has been exceeded on the first dayfollowing 50-70% of the time. In almost all markets studied,the analysis suggests the historical probability of exceeding alimit price is often greater than 80% within 3 trading days,and 90% within 7 trading days.

Many thanks to the Moore Research Centre (MRCI) and Jim Wyckoffin the writing of this article.

“A PRICE AT THE LIMIT OF A TRADABLE DAILY RANGE, ONCEREACHED, BECOMES AN OBJECTIVE WHICH THE MARKET WILLAGAIN TEST AND ULTIMATELY EXCEED, AT LEAST BRIEFLY AND

USUALLY SOONER RATHER THAN LATER.”


Techniques


Techniques


Techniques

Past performance The direction of equity market prices isnot really dependent on whether aRepublican or a Democrat president iselected. Recent presidential periodshave shown solid equity markets underboth Clinton (Democrat) and Regan(Republican). Thus the election cycledoes not differentiate between politicalparties but rather according to the yearof the presidency. During the last hun-dred years or so the Dow rose on aver-age 7.3% during a presidential electionyear. In pre-election years it performedon 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 betweenequity market performance and the yearof the presidential election cycle alreadyexisted during the 1800s. So, for a mar-ket gauge it is a statistically well ground-ed relationship.

Reasons for the cycle Why are the years after an election weakand the two years prior to an election sogood for equity markets? The reasonsare obvious: Presidents want to be re-elected (or want a successor from theirown party) and so work to stimulate theeconomy prior to an election in aneffort to get voters on their side. This

may include measures financed throughdeficit spending and the (not complete-ly independent) Fed supporting eachincumbent president through its mone-tary policies. But after the electionunpopular measures are piled on suchas those designed to counter a sprawl-ing federal deficit. Figure 1 shows a typ-ical four-year election cycle going backto 1897.

The vertical scale displays perform-ance on a percentage basis. So in thefirst section of the chart above“Election” you see the average per-formance of all election years, above“Post-Elect.” the performance of allpost election years is shown, above“Midterm” the performance during themiddle part of the cycle, and above“Pre-Election” the performance of

2008: Presidential Election Cycle UpdateBy Dimitri Speck

Dimitri Speck of Seasonal Charts looks again at the cycle and how stockmarkets may move as the election day approaches

Figure 1.

→→

all those years directly preceding anelection year. Average performanceduring the entire four-year cycleamounted to 25% on average. The horizontal scale shows each year

of the four-year cycle. As previouslymentioned, election years (on the left)and pre-election years (on the right)have been good years for the stock mar-ket. Both of the middle sections of thechart, i.e. the post election year and themidterm year hardly provided investorswith any profits. Let's now take a closerlook at the cycle’s current year, the elec-tion year.

Election year Figure 2 shows the average perform-ance during election years only. Theweakness during the first half of theyear is clearly visible. Then the Dowrises during the second half of the yearin typical fashion with a high inNovember with Election Day. So dur-ing election years, stocks move exactlyopposite to their typical annual season-al pattern when they usually increaseduring 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% priceincrease and a 10% price decline. The

point is that many different values go into making up an average. Accordinglythere have also been exceptions duringelection years. For instance, of the lastseven election years, two - 1984 and2000 - ended in losses. So, one shouldnever expect the same results withevery election year. In addition, theelection cycle itself could change in the

future - although its fundamental caus-es should remain relatively stable. Thisassumption is supported by the obser-vation that the economic cycle seemsto be subject to a four year pattern(Figure 3).

Forecasting with the cycle The four-year election cycle can serveas one of many decision-support tools.What it ultimately does is increase theprobability of a price move. A cyclicalpattern is namely one among severalinfluential factors on price directionsuch as sentiment, the dollar, oil, earn-ings and the like. Thus it is feasible tointegrate the cycle into a widely-struc-tured forecasting model as one of anumber of decision-making factors.This is suitable for discretionary tradingdecisions as well as for systematic trad-ing approaches. In the process all inputfactors are weighted and taken togetheras a total. Anyone basing trading decisions on

monetary policy, crude oil prices, thecurrency situation and stock markettrends can also use the election cycle asan additional decision factor.Unfortunately one cannot knowbeforehand which weighting an individ-ual factor will have. In addition


Techniques

Figure 2.

Figure 3.

→→


Techniques

there are factors such as the currentcredit crises whose influence on pricescan hardly be quantified in advance.

Other market cyclesIt must be stressed that the electioncycle does not end with the electionyear. It also influences the subsequentthree years, although the media pays lessattention to it. Next to the US stockmarket, the currency and bond marketsalso possess four-year cycles. Especiallynoticeable in the bond market is the factthat the year prior to an election is typ-ically quite weak. It is exactly reciprocalto the stock market, strengthening theassumption that the two markets arecyclically connected to each otherthrough investment preferences andreallocation measures. Equity marketsin other countries also demonstrate afour-year cycle. This results from thedominance of the US markets whosedevelopments influence markets inother countries. Incidentally, that evengoes for countries that have their ownelection cycle running counter to thefour-year cycle.

Before and after Election Day Next to the election cycle there is stillanother, hardly noticed phenomenonrelated to the election. The movementof the US equity market directly beforethe election. In order to study it moreclosely, we’ve constructed a specialchart (Figure 4). It shows the Dow’saverage price during the weeks directlybefore and after Election Day. Thisoccurs during a period of six months –three months prior to the election and

three months following the election.Thus the day of the election is used asan anchor for the study as opposed tothe calendar. Indeed, the election doesnot always take place on the same day ofthe year. In this way a higher level ofaccuracy is attained for detailed analysissurrounding the actual election date.We can clearly see that in the days

prior to the election, stock marketprices tend to increase sharply. In a sim-ilar way, statistics show that marketstend to be positive prior to holidays.Apparently these two phenomena arerelated. The backdrop is likely that themood tends to be positive before spe-cial days as investors do not only makerational decisions but rather emotionalones as well. Likewise, prior to an elec-tion the mood improves as people hopefor their candidate’s victory and fresh

impulse is expected from the new teamin the White House. This optimism,even if it is caused by something unre-lated, stimulates the tendency to buy.

Figure 4.

Dimitri Speck, Seasonal Charts

“DURING ELECTION YEARS, STOCKS MOVEOPPOSITE TO THEIR TYPICAL PATTERN WHENTHEY INCREASE DURING THE FIRST HALF OFTHE YEAR AND PERFORM MODESTLY DURING

THE SECOND HALF.”

An amazing correlation exists between the phase of themoon and the timing of major US financial panics. Figure 1plots annual one day (AOD) falls1 greater than 4.25% for theDow Jones Industrial Average (DJIA) against the lunar cycle,between 1915 and 1999. AOD falls in the DJIA greater than4.25%2 have nearly always appeared in two quarter segmentsof the lunar phase: between the first quarter and full moonand between the third quarter & new moon, the only anom-aly being in 1930.3

If we extend the timeframe back to 1910 and forward to thepresent, we can add the events listed in Table 1

AOD Fall Event DJIA% Fall Phase Angle

Jan 20, 1913 One day fall -4.90 153 Jul 30, 1914 Onset of WW1 -6.63 099 Apr 14, 2000 Tech Wreck -5.64 130Sep 11, 2001 WTC attack na 281Jul 23, 2002 One day fall -4.64 122Jan 21, 2008 (a) Stock market panics na 169Sep 15, 2008 After Black Sunday -4.41 184Sep 29, 2008 Bailout rejected -6.98 004

Of the total 31 major DJIA AOD falls (> 4.25%) since1910, only the 1930 event did not occur when lunar phasewas within the two quarter segments noted in the diagram,(ranges: 085 to 185 Ao and 280 to 005 Ao). This finding isextremely significant and would be equivalent to tossing acoin 31 times and getting 30 heads. However, it’s worth not-ing that this lunar phase effect does not apply before 1910 orto DJIA AOD falls below 4.25%. It also does not show upin FT-30 daily data post 1935.One obvious question arises: Why does a correlation exist?

Presumably it has something to do with moon sun tidal →→

Figure 1. LUNAR PHASE & MAJOR DJIA AOD FALLS 1915 –1999. Note: The angular degree (Ao) between the moon and thesun (lunar phase) increases on the chart in an anti-clockwisedirection, i.e. 90 degrees is equivalent to South on the chart and270 degrees is equivalent to North.

Table 1. (a) Worldwide stock market panics occurred on this day.The US stock market was closed for the Martin LutherKing Jr holiday.

OBSERVATIONS ONLUNAR PHASE & US PANICSBy David McMinn

Is there a link between the moon and the markets?

LUNAR PHASE & MAJOR DJIA ONE DAY AOD FALLS

1915 - 1999

1 The annual one day fall is the biggest one day % fall in the yearcommencing March 1.

2 The -4.25% cut off was chosen from the data. For one day falls lessthan this there was no significance.

3 This diagram was first presented by myself in 2000 and publishedby the Australian Technical Analysts Association: McMinn, David.Lunar Phase & US Crashes. Australian Technical Analysts AssocJour. p 20, Jan/Feb 2000.


Techniques

harmonics, although how this functions remains unknown.And whilst it’s true that correlation does not equal causation,these and many other correlations support a strong moonsun affect on market activity. Such findings confirm the ideathat markets are cyclical and past activity is indeed indicativeof future outcomes. If you list DJIA market highs by the year, they will not cor-

relate with lunar phase. However, if you list the highs bymonth – day (year ignored) excellent relationships can beestablished. If the peaks at the beginning of a bear marketoccur around the same month, the moon ans sun will be insimilar ecliptical segments, giving rise to similar lunar phasesand market outcomes. The best example occurs for theSeptember 3, 1929 and August 25, 1987 peaks, both of whichtook place just after the new moon and both were followed55 days later by spectacular October panics. The violent mar-ket decline lasted only a few months, with the DJIA hitting abottom on November 13, 1929 and December 4, 1987. For1929 and 1987, there was an interval of 717.0 lunar monthsbetween the spring lows, the record highs, the autumn highs,the panics, the recoveries and the major post crash one dayfalls (Carolan, 1998, McMinn, 2006).

Where are we now? The 2007 to 2008 market crisis has historic parallels. Therecord DJIA high occurred on October 9, 2007, which wasclose to the September highs in 1895, 1899 and 1912. Eachof the four highs was followed by a major crash 104 to 112days later (see Table 2) and a protracted market decline there-after. Market Interval 1 Day FallHigh > 4.50% Interval Low

1895 (a) 107 days 1895 (a) 232 days 1896Sep 04 Dec 20 Aug 08

1899 104 days 1899 280 days 1900Sep 05 Dec 18 Sep 24

1912 112 days 1913 556 days 1914Sep 30 Jan 20 July 14

2007 104 days 2008 (b) ??? ???Oct 09 Jan 21

Curiously, major events in the current market have takenplace 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.

DJIA World Black BlackPeak Panics Sunday Monday

2007 2008 2008 2008

Oct 09 + 3.47 Jan 21 + 8.03 Sep 14 + 0.51 Sep 29

346 A° 169 A° 172 A° 004 A°

We are now going through the long bear market period.Unfortunately, timing the final low using past analogies is dif-ficult. As can be seen in Table 2 the interval between the oneday fall and the market low ranges from 232 days to 556 days,which is not helpful. However, picking the low in the currentturbulent market will have immense financial rewards.

References Carolan, Christopher. Autumn Panics. The MarketTechnician. Journal of the Society of Technical Analysts. p12. July 1998.McMinn, David. Market Timing by the Moon & the Sun.Privately published. 2006.

© Copyright 2008. David McMinn. All rights reserved.www.davidmcminn.com

Table 2. (a) Based on the 12 Stock Average index.(b) This date witnessed worldwide stock market panics,although the US market was closed because of the MartinLuther King Jr holiday. Even so, January 21, 2008 has beentaken as the DJIA one day fall.


Techniques

presents

A premier event for traders and investment managers

Speakers include:

FX Trading2008

24 October 2008

30 Pavillion Road

London SW1

Topics Covered: Who should attend:

Gerry Celaya Redtower AssetManagement

Xavier Porterfield FX Concepts

Francis Breedon Imperial College

Kristjan KasikovCitigroup

Elena Ambrosiadou IKOS AssetManagement

Per-Erik Karlsson Advantage Financial

+ Intra-day volume + Advanced trend following + Future of the carry trade + Top currency fund techniques + Time-of-day patterns + Long term FX strategies

+ Fund managers + Hedge funds + Traders + Risk managers + Analysts + Brokers

The Technical Analyst is proud to present “FX Trading Strategies”, a one day seminar for traders, investment managers and analysts. Bringing together leading experts in the field of currency trading and fund management, the event will look to assess the effectiveness of the various FX trading strategies such as trend following and the carry trade in the current market climate.

Web: www.technicalanalyst.co.uk

Telephone: +44 (0)1483 573150Email: [email protected]

Strategies

Register Today!Delegate fee: £495 + VAT

Stumbling on Happiness1 is a book by Daniel Gilbert, HarvardUniversity professor of psychology, about “the foibles ofimagination and illusions of foresight that cause each of usto misconceive our tomorrows and misestimate our satisfac-tions.” So what does Stumbling on Happiness have to do with value

investing? First, many studies have illustrated the potentialbenefits of value investing. The value investing approachhinges upon taking advantage of discrepancies between asecurity’s price and its underlying value. Value investors tend topurchase a security when it is out of favor and selling at a dis-count to its true or “intrinsic” worth. Then, as otherinvestors recognize this value, the price of the security typi-cally rises. The Brandes Institute has published researchreports (such as our “Value vs. Glamour” series) that echothe findings of various academics and illustrate the merit ofvalue investing. Value investing sounds simple – and has beenshown to work. So why don’t more people adhere to thisapproach?Using excerpts and examples from Gilbert’s book, this arti-

cle seeks to illustrate a variety of psychological pitfalls thatmay prevent people from achieving long-term success asvalue investors. The titles for each section are borrowed fromchapter titles or subheadings in Gilbert’s book. We beginwith presentism.

“Presentism” in the PastGilbert defines presentism as “the tendency for current expe-rience to influence one’s views of the past and the future”.For investors, this tendency points to the dangers of extrap-olation. We may find it difficult to believe that a securitywhose price has gone up recently could ever be a bad invest-ment. Conversely, we may have trouble envisioning a securi-ty that has been a poor performer recently ever being a goodinvestment. Value investors need to counter the tendency toextrapolate what is happening today and look at thingsrationally by comparing business values with security prices.This may sound reasonable – until we realize that the very actof making comparisons may trigger some behavioral traps.

Comparing and PresentismGilbert points out that how we make comparisons affects ouremotional response. And this may influence our decisions.He writes, “. . . (a) value is determined by the comparison ofone thing with another; (b) there is more than one kind ofcomparison we can make in any given instance;and (c) we may value something more highly when we makeone kind of comparison than when we make a different kindof comparison”. Often, market participants may get into

1 Gilbert, Daniel. Stumbling on Happiness. New York: Knopf, 2006.

Stumbling onValue Investing

→→

Behavioural biases play a dual role in the markets. Firstly, they can be viewed asthe biases that a trader or investor should try to avoid in order to take a morerational 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 preventinvestors from taking a purely rational value-based approach.


Techniques

trouble when they “compare with the past” by comparing asecurity’s current price with its past price. Many investors“anchor” on the purchase price for a security. For example, ifthey buy a stock at $40 a share, they constantly compare itsperformance with that original cost. Thus, if the stock pricedrops to $30, they tend to get upset. But looking at a stock’scurrent price vs. its purchase price is only one way to make acomparison. If the value of the business remains $70 pershare, a decline to $30 represents an even greater discount –and perhaps an opportunity to purchase additional shares. In an example, Gilbert writes that “. . . people are more

likely to purchase a vacation package that has been markeddown from $600 to $500 than an identical package that costs$400 but that was on sale the previous day for $300. Becauseit is easier to com-pare a vacation pack-age’s price with itsformer price thanwith the price ofother things onemight buy, we end uppreferring bad dealsthat have becomedecent deals to greatdeals that were onceamazing deals”.

DisambiguatingExperienceThere is an old WallStreet adage, “Neverget emotional about stock.” Great advice – but very difficultto put into practice. According to Gilbert, there is a reasonwhy we tend to get emotional – our brains take life’s ambigu-ities and reshape them into “good” things or “good” experi-ences once we are personally involved. A stock in the UnitedStates, one of thousands of securities we could own, is ratherambiguous – until it’s in our portfolio. At that point, investorsmay get emotional about their holdings. According toGilbert, “. . . as soon as we have a stake in its goodness – our

brains get busy looking for ways to think about the experi-ence that will allow us to appreciate it”. As examples, Gilbertcites studies in which consumers, job seekers, high school stu-dents, gamblers, and voters rated their appliances, jobs, col-leges, horses, and candidates more positively after they pur-chased, accepted, enrolled in, wagered on, or voted for them,respectively.

Challenging FactsOnce we have formed an opinion about something, it can bedifficult to change it. Often, our perceptions and hypothesesbecome our realities – regardless of the facts. Gilbert noteswe 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-gence of another person.When the person being evaluated was perceived to be

“funny, kind, and friendly,” little evidence was required.However, if the person being evaluated was perceived to be“unbearable,” volunteers required much more evidence.Thus, when we want to believe something, just a few facts canconvince us. As such, people would be wise to actively seekout information that counters our conclusions when makinginvestment decisions. And we should seek a great deal of thiscountering information.

Valuing Things DifferentlyWhy can it be so hard to be a patient investor? Gilbert mayoffer some insight when he writes, “The fact that we imagine

the near and farfutures with such dif-ferent textures causesus to value them dif-ferently as well”. Hecites an example ofpaying for aBroadway show tick-et. Most peoplewould be willing topay more for a ticketto a show tonightthan a ticket to thesame show nextmonth. “Delays arepainful,” he writes,“and it makes sense

to demand a discount if one must endure them.” But he addsthat studies show when people imagine the pain of waiting,they expect it to be far worse in the near term vs. the longterm. “And this,” Gilbert contends, “leads to some rather oddbehavior”. For example, most people would rather get $20 ina year than $19 in 364 days. Apparently, a one day delay thattakes place in the far future looks (from here) to be a minorinconvenience. But – most people would rather receive $19today than $20 tomorrow because a one-day delay that

“WE END UP PREFERRINGBAD DEALS THAT HAVE

BECOME DECENT DEALS TOGREAT DEALS THAT WEREONCE AMAZING DEALS”

→→


Techniques


Techniques

takes place in the near future looks (from here) to be unbear-able.“Whatever amount of pain a one-day wait entails,” Gilbert

writes, “that pain is surely the same whenever it is experienced;and yet, people imagine a near-future pain as so severe thatthey will gladly pay a dollar to avoid it, but a far-future pain asso mild that they will gladly accept a dollar to endure it”.Value investing likely will not trigger that part of our brain

that generates feelings of pleasure in the short term. (Suchfeelings of excitement help drive gamblers into casinos, notinto value managers’ offices). Value investing often doesn’tfeel 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 canaffect our long-term rationality.

The Least Likely of TimesPeople tend to remember specific, infrequent experiences. Wetend to remember the best and worst of times vs. most of thetimes. And this can affect decision-making. For example,Gilbert highlights how our reaction to the way a movie endsinfluences our perception of the entire film. “The fact thatwe often judge the pleasure of an experience by its endingcan cause us to make some curious choices”. There are par-allels when investing: We might tend to remember withgreater clarity the bad investments we have made – especiallyif they have happened recently and ended with great pain(large losses). The sharp emotions connected with theseshort-term experiences may affect our long-term investmentapproach.

Paradise GlossedPerhaps we have heard the theory that negative events canhave twice the emotional effect as positive events. For exam-ple, a $10,000 investment gain might earn us one “point” onan emotion based scale. However, losing $10,000 wheninvesting would feel like losing two points. Same amount ofmoney involved – but twice the emotional impact when los-ing money. This may be true, yet Gilbert argues that thehuman spirit is very resilient. He writes, “The fact is that neg-ative events do affect us, but they generally don’t affect us asmuch or for as long as we expect them to”. So this is greatnews, right? So why do we still have such trouble focusing onthe long term? The answer: we continually subject ourselvesto an assortment of short-term stimuli.Successful value investors may remember a handful of

clunkers, but, over time, the short-term emotional pain asso-ciated with these few holdings fades when they realize theirlong-term success. Yet it can be difficult to shed the emotion-al drag of short-term pain when we expose ourselves to it sofrequently.

Looking Forward to Looking BackwardGilbert uses two investment scenarios to illustrate the influ-ence of regret:

1. You own shares in Company A. During the past year, youconsidered switching to stock in Company B but decidedagainst it. You now find that you would have been betteroff by $1,200 if you had switched to the stock ofCompany B.

2. You also owned shares in Company C. During the past yearyou switched to stock in Company D. You now find outthat you’d have been better off by $1,200 if you kept yourstock in Company C.

Which scenario causes more regret? Nine out of 10 peopleexpect to feel more regret by switching. But Gilbert notes, “. .. in the long run, people of every age and in every walk of lifeseem to regret not having done things much more than theyregret things they did. . . ”. Thus, not switching stocks (scenario1) causes more emotional stress. Why? We tend to reward our-selves mentally for taking action – even if it’s the wrong action.Our “psychological immune system” has trouble making usfeel good about inaction. In other words, doing nothing rarelyfeels very good. This is another reason why value investingcan be so difficult. Often, long-term success depends uponinaction. But not taking action may trigger sharp pangs ofregret – especially in the short term if prices for holdingsdecline. The successful value investor may have to wait threeto five years or more to be rewarded. That can be a long timeto “do nothing,” a long time for regret to build.

Brandes Institute Research Paper No. 2007-05, August 2007. Thismaterial was prepared by the Brandes Institute, a division of BrandesInvestment Partners®. Please visit www.brandes.com/institute for thefull version, (also available from www.ssrn.com).

VOLUNTEERS WERE ASKED TOJUDGE THE INTELLIGENCE OFANOTHER PERSON. WHEN THEPERSON BEING EVALUATED WASPERCEIVED TO BE “FUNNY, KIND,AND FRIENDLY,” LITTLE EVIDENCEWAS REQUIRED. HOWEVER, IFTHE PERSON BEING EVALUATEDWAS PERCEIVED TO BE “UNBEAR-ABLE,” VOLUNTEERS REQUIRED

MUCH MORE EVIDENCE.

VOLATILITY TRADINGUSING THE VIXBy Carley Garner

The adage ‘buy low and sell high’ was originally used in refer-ence to price, but can also be applied to the practice of trad-ing volatility. In fact even if you do not trade volatility ignor-ing measures of potential explosiveness while entering orexiting a market could mean financial peril. While manytraders understand the concept of buying options duringtimes of low volatility and selling them during times of highvolatility, emotions often lead a well planned strategy astray. Unlike traders that are looking to profit from a directional

move in price, volatility traders are more interested in thepace at which the market is moving than in its direction.However, it is important to chart both price and volatility.Doing so provides trades with a better understanding of the'big picture'. In my opinion, the most efficient means of trading US

equity market volatility isn't through the VIX index or anyother similar measure. Liquidity is a major factor workingagainst the viability of doing so. Instead, I believe that tradersshould look to buy or sell options on S&P 500 futures. TheS&P is a broad based index and its value is sharply impactedby market sentiment and the corresponding volatility. Thus, atrader that is of the opinion that volatility will increase maylook to buy volatility through the purchase of options writ-ten on S&P 500 futures, and those looking for volatility todecrease may look to sell volatility by going short options onthe index.

Trading Volatility through Premium Collection As mentioned, one way to speculate on variations in volatili-ty is through the practice of option selling, often referred toas premium collection. Option sellers are in the business ofcollecting premium, much like an insurance company, underthe assertion that in the long run the premium collectedshould outweigh any potential payouts. This theory is basedon the assumption that more options than not expire worthless which has been suggested by several studiesincluding one conducted by the Chicago MercantileExchange. Unfortunately, just as insurance companies aresometimes forced to honor their policies on excessive claims,option sellers are vulnerable to monster market moves thancan be potentially account threatening. Preventing such disas-

ters ultimately comes down to timing of entry along with agood understanding of volatility, market sentiment and mar-ket knowledge. Additionally, experience, instinct and, ofcourse, luck will also come into play. Yet, in my judgmentoption selling is a superior strategy in the long run.Options selling advocates and equity market volatility

traders seem to migrate to the S&P 500 futures market. Boththe full sized and mini versions of the contract provide ampleliquidity to actively trade the market without the burden ofunreasonable bid/ask spreads.

CBOE's Volatility Index (VIX)An important measure of volatility when referring to theS&P is the now infamous Chicago Board OptionsExchange's Volatility Index, often simply referred to as theVIX. According to the CBOE, the VIX is a "key measure ofmarket expectations of near-term volatility as conveyed byS&P 500 stock index option prices" and has become one ofthe most prominent measures of market sentiment in theworld. Before 2007 the VIX spent a majority of its timebelow 20, it is now obvious that times have changed....at leastfor now. Keep in mind that there were adjustments made to the

parameters of the index in 2003 that may have arguablyaffected the value of the index. For our purposes we will dis-regard the possible discrepencies. It is important to note that increased values of VIX are

highly correlated with higher option premium in the form ofhigher implied volatilities and are ideal conditions for anexperienced option seller assuming that they are willing toaccept the risk of participating in such a market.

The Quest for Implied VolatilityUnlike the VIX which is derived from the underlying futuresprice among other factors, implied volatility is a componentof option price. The implied volatility of an option, is theamount of volatility implied by the market value, or price, ofthe option. In other words, the implied volatility is forwardlooking in that it incorporates the current market precarious-ness as well as what market participants are expecting at somepoint in the future.


Techniques

You may also find that market emotion and sentiment area component of implied volatility. As traders scramble to golong volatility through the purchase of options in an attemptto profit from the latest hype, option premiums can and doexplode exponentially. As a sidelined option seller, thesetypes of conditions should be inviting. The premise of thisapproach is to attempt to sell options to buyers that are sim-ply "late to the party". The key is making sure that as a sell-er you aren't too early.

Selling Puts can be Lucrative, but it Comes witha Hefty Price TagIt is often the case that selling puts is more lucrative thancalls, but the added reward carries baggage in the form ofadditional risk. Due to the increased levels of risk, timingbecomes crucial. By nature an option selling program tendsto leave room for error in the execution. Nonetheless, beingshort puts in a spiraling market can quickly change that. The phenomenon of put premium in the stock indices

being larger than call premium is often referred to as thevolatility smile. The volatility smile is a long observed patternin which at-the-money options have lower implied volatilitythan out-of-the-money options along with the argument thatthere is more value in owning a put relative to an equally dis-tant call. This scenario seemed to be born after the crash of1987 in the U.S. While there are no crystal balls to let us know when a mar-

ket will turn around and how low that it may go before itdoes, being aware of historical patterns in price, volatility andmarket sentiment may help to avoid a compromising situa-tion. Let's take a look at the relationship between the VIXand the S&P.

VIX and the S&P 500Looking at Figure 1, it is obvious that the S&P 500 has beenable to forge recoveries during times of spiked volatility asmeasured by the VIX. Armed with this knowledge, it may bea viable strategy to look at erratic, and many times irrational,trade as a point of entry for put sellers.

For example, based on this assumption put sellers mayhave fared well during the lows in 1998, 2001, 2003 and 2007.That is of course assuming that the trader wasn't early in hisentry. If a short volatility trader enters a market prematurely,there is a strong possibility that the trader will be forced outof the market prematurely due to lack of financing or mar-gin. Let's take a look at an example of a trader that is inter-ested in selling volatility by going short S&P puts. Beginning in the middle of 2002 and throughout the begin-

ning of 2003, put sellers with savvy timing may have donevery well. However, trading is a game of risk and those sell-ing puts during those times were accepting great amounts ofrisk in order to reap the reward. Let's take a look at a continuous S&P 500 futures chart

during the 2002/2003 lows in Figure 2. While the VIX is agreat indication of volatility and extreme market sentiment, itis also helpful to look at indicators of volatility such as stan-dard deviations. Luckily, the creation of Bollinger Bandsallows us to visually determine market volatility through theline plot of two standard deviations from its mean. Times ofhigh volatility are denoted by wider bands, or a larger stan-dard deviation, and times of decreasing volatility result innarrowing bands. As market volatility increases, so will option prices. During

such times, option buyers are forced to pay extremely highprices for options that in theory are more likely to expireworthless than not. On the other hand, option sellers are pro-vided top dollar for accepting theoretically unlimited risk.

Higher premiums collected not only increase a tradersprofit potential but it also increases the room for error. Themoney collected for a short option can be viewed as "cush-ion" in that it defines the amount in which the trader can bewrong and still make money by shifting the reverse breakeven further from the market. The Reverse Break Even(RBE) of a short put is calculated as follows:

Figure 1.

"IT IS IMPORTANT TOCHART BOTHPRICE ANDVOLATILITY."


Techniques

RBE = Put Strike Price - Premium Collected + Commissions and Fees

As you can see, the more money that the option seller col-lects, the deeper-in-the-money the option can be at expira-tion without resulting in a loss to the trader.According to the hypothetical data available to us, in July of

2002 with the September futures price near 780, it may have

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-missions and fees. If this was the case, a trader could havecollected a little over a thousand U.S. dollars for an optionthat was, at the time, approximately 100 points or nearly 13%out-of-the-money.

At expiration, this trade would yield the maximum profit of$1,075 before commissions and fees if the futures price isabove 680 (see Figure 3). Ignoring transaction costs the RBEon the trade is at 675.7. This simply means that this particu-lar trade makes money with the futures price trade anywhereabove 675.7 before commissions and fees. Please note thatthe amount of commission paid will reduce the premium col-lected and shift the RBE closer to the market. To look at it inanother perspective, the trader can be wrong by 104.3 pointsafter entering the trade and still manage to break even. If thetrader's goal is to put the odds in their favor, this seems to bethe solution.

ConclusionWithout regard to transaction costs, trading is a zero sumgame; for every winner there will be a loser. Thus, puttingyour odds ahead of those of your competition is a must. Inmy opinion, selling options during times of high volatilitywhile exercising patience and incorporating experience isdoing just that. With that said, where there is reward there is risk; in effi-

cient markets you cannot have one without the other. Thisstrategy should only be attempted by those that have amplerisk capital to allow for potential draw downs as well as theability to manage fear and greed. Fearful traders are vulnera-ble to panic liquidation at inopportune times in terms ofmarket volatility and option pricing. Likewise, greedy tradersare tempted to sell options closer-to-the-money in hopes ofhigher payouts but the risk may turn out to be unmanageable.I strongly believe that less is actually more when it comes topremium collection. Trade less, collect less and hopefullyenjoy more success.

Carley Garner is the Senior Analyst of DeCarley Trading LLC whereshe also works as a broker. Her book, "Commodity Options" publishedby FT Press will be on shelves in January 2009. V isitwww.DeCarleyTrading.com for your free subscription to Carley's e-newsletters and for details on the services she provides.

Figure 3.

"THE S&P 500 HASBEEN ABLE TO

FORGE RECOVERIESDURING TIMES OF

SPIKED VOLATILITY."

Figure 2.


Techniques


Techniques

TD-Wave- A rule based approach to Elliott Wave analysisBy Trevor Neil

Tom DeMark is adamant that subjective methods used in technical analysis can-not be trusted. When technical analysts cannot agree amongst themselves how todraw them, how can they be tested and how can be people be confident in usingthem? Perhaps the most subjective of all technical analysis methods is ElliottWave analysis. There is a joke amongst technical analysts - bring together fiveElliott 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, sostrict that a computer can calculate them and display them, marking up the wavecounts according to defined rules. With his rules, everyone sees the same thing andmakes the same correct count (if you agree with his rules). Elliott wave is nowobjective and mechanical - This is Tom DeMark’s D-Wave.

D-Wave rulesD Wave constructs Elliott cycles with user defined wavecounts. The trend cycles develop with five impulse wavesfollowed by a counter trend pattern of three correctivewaves. The recommended D Wave settings suggest thewaves 1, 3, 5 will become increasingly more significant inthe development of the overall trend. The wave 1, 3, 5, andB counts require that the user specified price (high, truehigh, close) must be higher than the previous 'N' number ofbars: the 2, 4, A, and C counts require that the specifiedprice (low, true low, close) must be lower than the previous'N' number of bars in an upward trend.

Conversely, wave 1, 3, 5, and B counts require that theuser specified price (low, true low, close) must be lower thanthe previous 'N' number of bars, while the 2, 4, A, and Crequire that the specified price (high, true high, close) mustbe higher than the previous 'N' number of bars in a down-ward trend.D-Wave uses patterns that are defined by a series of

Fibonacci highs and lows. This approach makes a D-Waveobjective, e.g. Wave 1 could be identified as an 8 bar high, ahigh higher than all previous 7 bars' highs. The succeedingwaves 2, 3, 4, and 5, as well as the correction waves, useFibonacci numbers. →→

D-Wave displays waves according to the following logic:

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 Wave 2-5 Low Wave 3-13 High 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 ProjectionsPrice projections are created based on the length of a waveand Fibonacci extensions. To calculate the projection, youmust 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 theFibonacci number in the "Times" category. The resultingvalue is then added to the "At" wave start for an Up waveand subtracted from the "At" wave start for a down wave.

ExampleTo calculate the Wave 3 Objective, take the differencebetween the start and end of Wave 1 equalling 10 points.The difference is then multiplied by 1.618, resulting in avalue of 16.18. In a down sequence, this value would bededucted from the start of Wave 2, equalling 40 in theabove 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-riskbuy and sell trading zones. D-Wave takes a difficult andhighly subjective technique and turns it into a rule-basedmethod. It offers the flexibility of deciding what and howyou want the rules to be enforced but then will accuratelyimplement them.

Trevor Neil is CEO of Betagroup and head of training atthe Technical Analyst.

For further information on D-Wave, please refer to ThomasR. DeMark’s book, “The New Science of TechnicalAnalysis”, (New York: John Wiley & Sons, 1994).

Screen shots of D-Wave on Bloomberg

Wave Properties

DeMark D-Wave for the S&P500


Techniques


Techniques

SIZING UP A SUPERPOWER: A SOCIONOMIC STUDY OF RUSSIABy Alan Hall

Elliott Wave International analyst, Alan Hall, uses Robert Prechter's principleof Socionomics to tie events in Russian history to Elliott Wave cycles, andexplains why his analysis has serious implications for Russia and its neighboursgoing forward.

Looking Back: Russian History through aSocionomic Lens Russian history is a story of extremes — from battlegroundto superpower and back to second tier state, from totalitari-anism to dysfunctional democracy, from Gulag to glasnost,and from communism to a mixed economy. Politics andsocial landscapes tend to wax and wane along with the wavepattern. A stock market would certainly have reflectedRussia’s extreme social swings had the Kremlin allowed one.Stock market data provide an objective measure of the rela-tive optimism and pessimism of investors, so they serve asour primary indicator of social mood. Although there is nopre-1995 Russian stock market data, we observe that eventsin Russia have correlated well with the social mood of theU.S., as illustrated by trends in U.S. stock prices, which to asubstantial degree are correlated with social mood worldwide.A brief historical review will give some perspective. (SeeFigure 1)

1859-1892: Cycle Waves I, II and III The bear market of the 1850s produced the Crimean War(1853-1856), which devastated Russia. With 256,000 dead,Grand Duke Konstantin Nikolayevich said “… we are bothweaker and poorer not only in material but also in mentalresources, especially in matters of administration.” Positive events began in 1861 as wave I unfolded. Tsar

Alexander II emancipated the serfs in an attempt to relieverevolutionary pressures and move Russia out of its feudaleconomy. Living conditions for the peasants remained unfa-vorable, however. The wave II bear market produced several uprisings and a

capitulation. In 1864, Alexander declared the end of the longCaucasian War (1817-1864).The positive social mood that drove wave III from 1865 to

1892 generated no major conflicts and only one war, the briefRusso-Turkish War, from 1877 to 1878. (Note the pullback inthe middle of wave III.) This period of relative peace is whatwe expect from third waves.

1892-1920: Cycle Wave IV The wave IV bear market caused increasingly negative socialexpressions in Russia. The years 1901 through 1903 saw asteady increase in peasant revolts, in which mobs burnedmanor houses and mutilated animals. The Russo/Japan warwas initially popular in 1904 but ended in crushing defeat.The Russian Revolution of 1905 brought nominal reforms bythe Tsar, followed by a crackdown in 1906. The Tsar declaredabsolute executive power, then disrupted revolutionarygroups and imprisoned or exiled the groups’ leaders. By 1913, deep into wave IV, the average Russian was earn-

ing 27 percent of an average Englishman’s wages and paid50% more in taxes. The Cycle-degree global bear market

Figure 1.

→→


Techniques

and the decaying tsarist autocracy exacted terrible social costs.Russia had the highest mortality rate in Europe and a lowerliteracy rate than England 163 years earlier in 1750. The effects of negative social mood worldwide led to

World War I in 1914. By its end, 3.3 million Russians haddied, by far the largest death toll of any combatant nation.The massive social and political chaos at the end of wave IVdecimated manufacturing, foreign trade, agricultural produc-tion and Russia’s already poor per capita income, which fellover 70 percent. Radicalism tends to emerge and become entrenched in cor-

rective waves. Marxism was Cycle wave IV’s radical idea. Itencouraged the Russian Revolution of 1917, which ended thereign of the Tsars and eventually led to a savage civil war. In 1918, as the five-year civil war wore on and wave IV

approached its nadir, Lenin narrowly survived an assassina-tion attempt. Shortly afterward came the successful assassina-tion of a secret-police chief. Lenin then instituted a policy ofopen and systemic mass terror. His handwritten “HangingOrder” 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 andscapegoating:

11 VIII 1918Send to Penza To Comrades Kuraev, Bosh, Minkin and other PenzacommunistsComrades! The revolt by the five kulak volosts must be suppressed with-out mercy. The interest of the entire revolution demands this, because wehave now before us our final decisive battle “with the kulaks.” We needto 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.3) Take away all of their grain.4) Execute the hostages — in accordance with yesterday’s telegram.This needs to be accomplished in such a way, that people for hundreds ofmiles around will see, tremble, know and scream out: let’s choke andstrangle those blood-sucking kulaks.Telegraph us acknowledging receipt and execution of this.Yours, LeninP.S. Use your toughest people for this.

TRANSLATOR’S COMMENTS: Lenin uses the derogative termkulach’e in reference to the class of prosperous peasants. A volost’ wasa territorial/administrative unit consisting of a few villages and sur-rounding land. (Library of Congress, http://www.loc.gov/exhibits/archives/ad2kulak.html)

Scholars estimate that Lenin’s campaign caused the execu-tion of up to 200,000 people between 1918 and 1921. Theconcurrent civil war took the lives of seven to eight millionpeople, five million of whom died by famine. Overall, Cycle wave IV (1892-1920) wreaked tremendous

economic and social damage. From 1914 to 1921, Russia’spopulation crashed more than 22 percent. Industrial outputdropped 87 percent between 1913 and 1922, and gross cropyield fell by more than half. From these depths wave V insocial mood emerged, but due to the form of governmentthat took over in wave IV, Russia’s recovery was much slow-er than the rising social mood would have produced in a freersociety.

1920-1929: Cycle Wave V of Supercycle Wave (III) In 1921, the year after the rise of wave V began, Lenin aban-doned attempts at communal agriculture and allowed individ-ual farming. The following year, the U.S.S.R. was formed. By1926, agricultural output had returned to at least the pre-rev-olution level of thirteen years previous, and industrial outputdid so two years later. Compared to those in the West, mosteconomic recoveries in Russia look like half-hearted reliefrallies. That was certainly true of Supercycle wave (III), and itleft little for wave (IV) to draw upon.

1929-1948: Supercycle Wave (IV) The following quote describes how some points in the Elliottwave pattern allow unique social forecasting:

Forecasting Styles of Social EventsHere is another esoteric point but one of great value. A section on

“Nuances” in Chapter 15 of The Wave Principle of Human SocialBehavior explains that negative social themes due to appear in anyapproaching bear market first express themselves in milder form in thepreceding fourth wave of one lesser degree. Stop for a minute until youget this idea. Here is a more detailed explanation: Social mood repeat-edly traces out five waves up followed by three waves down. The negativethemes in “wave four” within the “fives waves up” presage those thatwill dominate, more dramatically and on a much bigger scale, in theensuing “three waves down.”

It is also true of the character of social events. In an earlier fourthwave from 1916 to 1921, collectivists took over Russia. In the largerfourth wave that followed, from 1929 to 1949, collectivists took overnearly half of the earth’s population, in Germany, Italy, EasternEurope and China. (The Elliott Wave Theorist, September 2001.)Sure enough, the collectivism and social repression


Techniques

"NEGATIVE SOCIAL THEMES DUETO APPEAR IN ANY APPROACHING BEAR MARKET FIRST EXPRESS

THEMSELVES IN MILDER FORM INTHE PRECEDING FOURTH WAVE OF

ONE LESSER DEGREE."

→→

that emerged in Cycle wave IV (1892-1920) foreshadowedwhat was to come in Supercycle wave (IV). Even at the peak of Supercycle wave (III), the Soviet econ-

omy was unable to support the growth of industry andarmed forces. Foreign investors were not interested in thecountry, and the middle class had been exterminated. Stalin,who took power after Lenin’s death in 1924, had few sourcesof revenue. He decided to plunder the 78% of the popula-tion in the private agricultural sector. In 1929, at the onset ofSupercycle wave (IV), he began transferring control of farms,equipment and livestock to the government. Farmers considered this policy a return to serfdom. They

resisted and destroyed about half the U.S.S.R.’s livestock —some 55 million horses and cows — whereupon Stalinresponded by sending about a million families into exile. Thisconflict, and a catastrophic decline in grain production, exac-erbated the famine of 1932-1933 that killed between five andten million people.Stalin’s move to bring farmers under state domination

revealed the classic bear market trait of the desire to controlpeople. By most accounts, Stalin was rude, ruthless, unforgiv-ing and without pity or empathy, and as the powerful wave(IV) bear market accelerated, his malevolence expanded dra-matically.Stalin’s purges and deportations were a huge magnification

of Lenin’s “Red Terror” campaign of the preceding fourthwave of one lesser degree. His massive social repressionspanned the period from 1929 to 1949, all of Supercyclewave (IV). His purges were initially aimed at the most pros-perous peasants (or “kulaks”) who resisted collectivization,but they expanded into a genocide in which tens of millionswere starved, exiled or killed. This wave also amplified anoth-er fixture of Cycle wave IV, the “katorga,” the predecessor ofthe Gulag labor camp. Supercycle wave (IV) ultimately gave rise to World War II.

The U.S.S.R. suffered the deaths of nearly 24 million civiliansand soldiers (13% of the population) at the hands of theAxis. The social environment today is so radically different that

few people can imagine the destructive power of aSupercycle fourth wave. Photos of the kind that appeared in1940s-era Life magazines — of the dead, wounded and gan-grenous — simply are not published in any mainstreammedia today. Stalin executed millions of comrades and other

Communist Party members, officers and even heroes in the Soviet Army — anyone who might have threatened hispower. He used fear, anti-Semitism, racial polarization, starvations and secret police to consolidate his power sofirmly that no political opposition was possible. He usedscapegoats to cover his failures and re-wrote history to his advantage. His police state forced Russians into sub-mission. His impetus to “cleanse” society escalated into masshysteria, in which people denounced their neighbors, co-

workers and even parents. The economic costs were immense, as the state killed the brightest or hauled them off to the gulag. Fear stifled innovation, experimenta-tion and constructive criticism and played a dominant social role.Fear is a key aspect of negative social mood. While democ-

racies typically oust leaders in bear markets, dictatorshipsseem to thrive on bear market fear. Stalin died a natural deathin office in 1953 while apparently planning yet another purgeof top men in his government.

1948-1965: Supercycle Wave (V)The upsurge in positive social mood in wave (V) pulledRussia out of its worst depths. From the turbulence ofSupercycle wave (IV), the communist state engineered aweapons and space program that gave it superpower status.With Stalin gone, the Communist Party resurged. In 1953,Nikita Khrushchev was confirmed as head of the CentralCommittee, and change was in the air. Social mood can make or break political careers, and the

politicians that thrive are either lucky or canny enough to ridethe winds of change. Prior to Stalin’s death in 1953,Khrushchev was a devoted Stalinist. In the 1940s, near theend of wave (IV), his participation in Stalin’s purges earnedhim the nickname “The Butcher of the Ukraine.” ButKhrushchev would soon put this past behind him. With perfect timing, in 1956, near the middle of wave I of

(V) in Figure 1, Khrushchev read a speech, “On thePersonality Cult and its Consequences,” denouncing Stalinand weakening the Stalinists in the government. This markedthe beginning of the “Khrushchev Thaw,” a socially morepositive period in which the Soviets partially reversed repres-sion and censorship, improved relations with the West andreleased thousands of political prisoners from the Gulags. During and just after Supercycle wave (V), the U.S.S.R. was

first in a number of critical space successes, including thelaunch of Sputnik into orbit and the first space walk. TheU.S. and U.S.S.R.’s achievements in space were an astoundingexpression of positive social mood that has not been equaledin the 35 years since. In the list of positive aspects of socialmood in chapter 14 of The Wave Principle of Human SocialBehavior, we see the ones that made this achievement possi-ble: adventurousness, clarity, confidence, constructiveness,daring, desiring power over nature, embrace of effort, opti-mism, practical thinking and sharpness of focus. It’s no coincidence that the U.S.S.R.’s moon landing came

the year of the top in the powerful 1965 Supercycle wave (V)peak in U.S. stocks. Three years later, as the achievementsderiving from a positive social mood peaked, the U.S. putmen on the moon.

1965-1982: Supercycle Wave (a)Conciliation and inclusion characterize large degree wavepeaks, and the peak of wave (V) brought about a cluster →→


Techniques

of arms control treaties. 1964 also marked the first major U.S.sale of grain to Russia. The superpowers adopted an attitudeof détente and they balanced in an uneasy truce.Wave (a) was characterized by indirect superpower compe-

tition, mainly expressed in proxy conflicts in the third world.The Soviets played a supporting role in wars in Vietnam,Somalia, Angola, Mozambique, Laos, Cambodia andNicaragua, while the U.S. government countered withmateriel and support for military coups.

As both superpower economies contracted, their spaceprograms atrophied. The Soviet Union continued to suppressdissent. In 1968 it sent about 500,000 troops intoCzechoslovakia to crush the Prague Spring and negatereforms that had promised new freedoms of speech, travel,debate and association. In December 1979, the Soviets began their ill-fated war in

Afghanistan. The U.S. boycotted the 1980 Moscow SummerOlympics, and the policy of détente became much lessrelaxed.

In 1980, near the bottom of wave (a), the U.S. electedRonald Reagan on a platform opposed to détente. In 1983 hegave his pivotal “Evil Empire” speech, describing theU.S.S.R. as “totalitarian” and attempting to take the moralhigh ground in the Cold War. This speech marked the end ofdétente and a new period of change within the U.S.S.R.

1982-1999: Supercycle Wave (b)Soon after wave (b)’s onset, the Politburo unanimously choseMikhail Gorbachev as General Secretary, and he began “per-estroika,” a process of restructuring that weakened theCommunist Party’s grip within Russia. He also applied a pol-icy of “glasnost,” meaning maximal transparency in the activ-ities of the Soviet government. On November 9, 1989, dur-ing the steepest ascent in wave (b), glasnost and freedomcame together, and the Berlin Wall fell in a global wave ofeuphoria.

In 1991, during a recession at the end of Primary wave((4)) in U.S. stocks, the KGB failed in a coup attempt against

Gorbachev, and the U.S.S.R. collapsed. In Russia, economiccrisis followed. The result was a shattered economy, millionsof Russians pushed into poverty, pervasive political corrup-tion, an explosion of organized crime and looting of stateassets. These developments were extreme given the smalldegree of the mood change, but the decades of structuraldamages ultimately deriving from the dark mood of 1917 hadleft little infrastructure or social organization to cushion thesetback.

But the positive mood trend resumed, and Gorbachevgave way to Boris Yeltsin, the first democratically electedpresident of Russia. The country even developed a stockmarket. The Russian Trading System Index (RTSI) formed in1995 and immediately began an ascent to a peak in late 1997.In 1996, in the heart of that bull market, Yeltsin won re-elec-tion, with help from newly wealthy “oligarchs,” businessmagnates. The First Chechen War was the only major Russianconflict of the period. The Russian financial crisis in August of 1998 accompa-

nied a global recession and a bear market in world commod-ity prices at a time when Russia got 80% of its revenue fromoil, gas, metals and timber. Despite an IMF bailout, Russiadramatically devalued the ruble to avoid default. Investorsfled the country and the RTSI fell below its starting level, tak-ing Yeltsin’s popularity with it and bringing his previously tol-erated buffoonery into sharp focus. Vladimir Putin theninherited a young bull market and a new uptrend in Russia’ssocial mood.

Elliott Wave ForecastFigure 2 is a chart of the Russian Trading System Index fromits inception. Our Elliott wave count in the RTSI showed inNovember 2007 that a clear five-wave advance beginning in1999 was near completion. During this time, the RTSIincreased by sixty-fold. As expected, this index has begun itsbiggest bear market since the five-wave pattern began. Theminimum probable drop — a move into the area of thefourth wave of 2004 — would more than halve the value ofthe index. Such a decline should produce financial and social events

of a character comparable to those seen during comparabledeclines in the past. Viewed in the context of Russian histo-ry, this outlook has serious geostrategic implications. Recent events do seem to foreshadow the expected social

character of the ensuing contraction. They suggest that abear market in Russia should be taken very seriously.

Social Signs of Coming Political DangerWhen social mood shifts from bullish to bearish at a largedegree of trend, people need to protect their assets andensure their livelihood and safety in advance. This requiresanticipation of major change, a difficult task due to thehuman psychological tendency to envision the future byextrapolating the present. Used correctly, the Wave Principleallows a certain degree of anticipation:

Figure 2.


Techniques

→→

The Wave Principle guarantees reliable forecasting only of probabilities.It allows us to predict some aspects of the future and not others. Forexample, early in a new social mood trend, we can forecast society’s com-ing character changes but not necessarily specific events. We can forecastthat a major rising impulse wave will bring an increase in goodwill andproductivity. The specific decisions that each man makes and the specif-ic social actions and events that result depend upon countless details andare therefore chaotic. As the trend progresses, however, we can watch forsigns to indicate such specifics and actually anticipate some of them quitewell, as demonstrated in Chapter 17. (The Wave Principle of HumanSocial Behavior, Robert R. Prechter, Jr. New Classics Library, 1999.Chapter 20, p. 404.)

Russia seems more ready to confront the U.S. today than atany time since the Cuban Missile Crisis, 45 years ago. Indeed,on October 26, Putin made a comparison to that dangeroustime, reversing the protagonists’ roles, with the U.S. this timeplacing missiles at Russia’s doorstep via the European missiledefense shield. The steadily increasing potential for conflictbetween the two superpowers represents the potential forserious trouble. On November 20, Putin warned that Russiawill react to a NATO military buildup on its borders. (BBC)Social mood change at large-degree turns is not instanta-

neous. It can seem broad and slow as it develops. Recent top-ics in the news that show how Russia is converting its new-

found prosperity into a growing military confidence includethe recent conflict with Georgia, resumption of bomberflights along the US East Coast, a new air defense system,new offensive weaponry such as nucleur submarines andICBMs, and recent announcements that the Russian Navywill return to the Mediterranean Sea through a port in Syria. In 1999, Putin told the Russian Federal Security Service

(FSB), “A few years ago, we succumbed to the illusion that wedon’t have enemies and we have paid dearly for that.” Onespokesman described Russia’s changing mood this way: “InGorbachev’s time Russia was liked by the West and what didwe get for it? We have surrendered everything: EasternEurope, Ukraine, Georgia. NATO has moved to our bor-ders.” (Economist)

Social ImplicationsThe stock market is our best indicator of social mood, so astock market forecast is first a social mood forecast, whichimplies a commensurate change in the social environment.Wave IV from 1892 to 1920 in Figure 1 retraced about 30percent 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 capitalfrom infrastructure to weaponry, and war and death on amassive scale. Although the coming bear market has startedfrom a much higher point, realization of our forecast for alarge-degree decline in the RTSI will have major negativeeffects on Russia, her neighbors and perhaps the rest of theworld.A long-term trend toward a positive social mood leads to

peace and political cooperation, and an extreme trend changein social mood toward the negative yields turmoil. A situationwhere social mood in both the U.S. and Russia is in declinewould be quite different from the Cold War that occurredduring a bull market. Russia’s long history of border wars and its desire to

reclaim the resources of satellite states lost upon the collapseof the U.S.S.R. make future border conflicts likely. NATO,Muslim and Asian countries border Russia on the west andsouth. The ethnic diversity within these states represents con-flicts-in-waiting for the xenophobia that attends bear mar-kets. Much as investors descend a “slope of hope” in a bear

market, we can expect the popular media to continue tounderestimate the seriousness of Russia’s steady resurgenceto the world’s second largest military power. One shouldremain alert to the patterns unfolding in the stock markets,the primary indicators of this social mood progression, andto social and political events in Russia.

Extracted from A lan Hall, November 2007, “Sizing up aSuperpower: A Socionomic Study of Russia”, Parts I & II, ElliottWave International.

Russia in positive mood. Putin’s approval rating isnearly 80%.


Techniques

presents

A premier event for trading and investment professionals

Speakers include:

Behavioural Finance

200825 November 2008

30 Pavilion Road

London SW1

Strategies for exploiting market inefficiencies

Web: www.technicalanalyst.co.uk

Telephone: +44 (0)1483 573150

Register Today!

Email: [email protected]

Topics include: Who should attend:

Delegate fee: £495 + VAT

+ Profit warning reactions + Prospect theory & allocation + Over/underreaction in stocks+ Post-bubble behaviour+ Herding characteristics+ Value investing and BF

+ Traders + Fund managers + Hedge funds + Proprietary dealers + Quantitative analysts

Roy BatchelorCass Business School

George BulkleyUniversity of Exeter

Bill KallinterakisDurham Business School

Stefan Rehder BayernLB

Volker HergertLGT Capital

Enrico De Giorgi University of Lugano

William ForbesLoughborough University

Behavioural Finance 2008 is a one day event for traders and investment managers looking to exploit market inefficiencies based on market psychology. Bringing together leading experts including fund managers, academics and hedge funds, this unique event will present delegates with the perfect forum to learn about and discuss the latest and most effective techniques in behavioural finance.

INTERV

IEW

Jason Perl is global head ofFixed Income, Currencies andCommodities TechnicalStrategy at UBS InvestmentBank in London. He and histeam provide short and medi-um term trading strategies andbespoke educational trainingsessions for clients. His area ofexpertise for the past 14 years isthe DeMark suite of markettiming indicators and he is theauthor of Bloomberg MarketEssentials: DeMark Indicators(Bloomberg Press).

Copyright UBS (2008)

Interview


TA: What was you motivation for writing your book onDeMark indicators?

JP: I was approached early last year by David Keller (thenhead of technical strategy at Bloomberg, now Director ofTechnical Strategy at Fidelity in Boston). Bloomberg wasthinking of producing a series of definitive books based onmarket timing and technical analysis techniques and Davidasked if I would be interested in writing a user guide to theDeMark indicators. I suppose like many authors, I was adamant that it was

never my intention to put pen to paper, but over the years anumber of UBS clients around the world had asked for edu-cational material covering the popular DeMark indicators, sothis was a great opportunity to address that demand. It wasalso a chance to answer a number of questions that peopleconsistently ask about DeMark’s work when they start usingthe indicators. Furthermore, very little information was avail-able about TD D-Wave (developed by Tom DeMark as anobjective and mechanical version of Elliott Wave), which was

generating a lot of interest and the book project gave me aplatform to discuss the subject in detail.Hopefully the finished product accomplishes what we set

out to do, i.e. providing a definitive information source forfirst time users, as well as a practical user guide for thosealready familiar with the studies. Of course, I was delightedwhen Tom DeMark offered to write the foreword and hon-oured that a number of high profile industry names; JohnBollinger, Peter Borish, John Burbank, Leon Cooperman andDavid Kyte endorsed the book.

TA:Which DeMark indicator do you use most often? Are there some that you think are more effective than others?

JP: Actually, rather than just one study, I use TD Sequential,Tom’s signature trend exhaustion indicator in conjunctionwith TD D-Wave. TD Sequential is good at identifyingprospective exhaustion points in both ranges and trends, but

it doesn’t give you an insight into the magnitude of theexpected reversal. I find that when using TD Sequential onmultiple time frames, combining it with TD D-Wave puts thesignals into context – i.e. are we mid-way through the impul-sive stage of a trend or in the latter part and therefore termi-nal phase when a macro move is more likely? Typically, I findthat TD Sequential signals in TD D-Wave 3 (the impulsivephase of a trend) are less reliable than TD Sequential signalsin TD D-Wave 5 (when the bulk of the trend has already hap-pened).As far as which indicators are more or less effective than

others, I think it’s more a question of what one’s investmentobjective and time horizon is. Tom has both trending andtrend exhaustion indicators in his suite of tools so in myopinion, it’s more a question of finding the DeMark indica-tors that suit the individual’s objectives and personality – asthe old trading adage goes – your chosen methodologyshould be defined by whether you wish to eat well or sleepwell. I don’t mean that flippantly: for example, counter-trendtrading is by definition counter-intuitive, so if you don’t like

going against the market consensus, then TD Sequentialprobably isn’t for you.

TA: Does the Sequential Indicator remain the most pop-ular DeMark indicator? If so, why do you think this is?

JP: Well, TD Sequential is probably the DeMark indicatorthat people are most familiar with. Firstly, it’s Tom’s signaturestudy so it’s generated a lot of interest in the 30 plus yearssince it was developed and along with its counterpart TDCombo, it’s also the study that differs the most from whatev-er else is available in the market.

TA: Have you done any back-testing of DeMark or doyou know of anyone who has? If so, what were theresults?

JP: Although I fully understand why new users would wantto back-test the DeMark indicators, I haven’t felt the need →→

“THE TD SEQUENTIAL IS PROBABLY THE DEMARKINDICATOR THAT PEOPLE ARE MOST FAMILIARWITH. ITS TOM’S SIGNATURE STUDY SO IT’S

GENERATED A LOT OF INTEREST IN THE 30 PLUSYEARS SINCE IT WAS DEVELOPED”

Interview


to do so personally because I’ve been using them real-timefor the past 14 years and have seen how they behave in alltypes of environment. Suffice to say, while I recognise theindicators are by no means infallible or indeed the Holy Grail,I do believe they give one a considerable edge when it comesto market timing if used in an objective and disciplined man-ner over time.A number of very smart people have tried to back-test the

indicators, but I should say that Tom is keen to emphasisethat his body of work is indicators, not trading systems. Sofor TD Sequential, one does get an entry signal and an initialrisk level but DeMark doesn’t provide information on how tomanage the risk once the trade starts moving in your direc-tion or advice on where to take profit. So if you did want toback-test the TD Sequential, you’d need to recognise that theresults are based on your interpretation of how to managethe risk and profit taking inputs.

TA: Presentations that we have heard on the Sequentialsuggests that the profitability of trading Setups andCountdowns lies not necessarily in the frequency oftheir success but rather in using them as a risk manage-ment tool. In effect, the gains from when the Sequentialworks are much bigger than the losses from when itfails. Do you go along with this?

JP: Yes, absolutely. Like I said, TD Sequential is by no meansthe Holy Grail, but it does provide some acute risk / rewardtrading opportunities, both in ranges and in the latter stagesof a trend. When used over multiple time frames and in con-junction with other TD indicators such as TD D-Wave, thehit rate on successful trades based on TD Sequential can besignificantly improved. Both Tom and I are keen to stress thatthe indicators are market timing tools rather than technicalanalysis per se. Increasingly I find non-technically orientedcustomers are recognising the added value the indicators pro-vide in terms of improving the efficiency of trade entry andexit in conjunction with a fundamentally driven trade idea.

TA: What, in your view, are the main weaknesses of theSequential Indicator?

JP: By definition, since TD Sequential is counter-trend so itwill have a tough time when markets are trending strongly inone direction. However, that’s precisely why I stress the needto evaluate each signal on a case by case basis and consider itin the context of the broader trend. One should always beaware of what the indicator is saying on longer-term timeframes (so you know whether you are trading in-line with oragainst the broader trend), and note where the signal lies rel-ative to the current TD D-Wave count. That won’t complete-ly offset the risk of being stopped out in strong trends, but it will certainly reduce the occurrence in a very objectivemanner.TA: What are the main advantages of using the TD

Combo versus just using the TD Sequential?

JP: Frankly, I always struggled to determine when one shoulduse TD Sequential rather than TD Combo and vice versa.Obviously, it gives one a greater sense of confidence if theTD Sequential and TD Combo happen to generate a signalsimultaneously, but since both indicators are trying to identi-fy trend exhaustion points it can be difficult rationalising apreference for one over the other.

However, a couple of things do stand out:

1) DeMark suggests TD Combo has a slight edge over TDSequential if one is trading off intra-day charts,

2) By definition, TD Sequential requires a minimum of 22price bars before it can generate a buy or sell signal subse-quent to a completed TD Setup and TD Countdown,whereas TD Combo only needs a minimum of 13 pricebars to generate a completed TD Setup and TDCountdown – so TD Combo is useful in determiningprospective trend exhaustion points after an abrupt direc-tional move. Again, combining the indicators on multipletime frames and coupling them with TD D-Wave givesone an objective insight into the most opportune time touse one rather than the other, particularly if the market hasreached a projected TD D-Wave target.

TA: What exit strategies do you use/recommend usingafter entering a TD Sequential triggered trade?

JP: DeMark doesn’t discuss this in detail, so this is my per-sonal interpretation;

1) Wait for a fresh signal in the opposite direction

2) Trade around prior TDST levels or

3) plot the distribution of signals generated by TD Sequentialover time and try to determine the most that the marketmoves on average subsequent to a signal or prior to a pull-back of at least x% - then use that as a take profit target,regardless of whether there is a fresh signal in the oppo-site direction or not.

TA: How has the use of DeMark changed over the pastfew years? If it has increased, why do you think this is?

JP: When I first heard about the DeMark indicators 14 yearsago, their use was limited to a relatively small number of peo-ple who were familiar with Tom and his work. The indicatorswere not available on the mainstream quote vendors as theyare now (such as CQG, Thomson and Bloomberg). Theintroduction of the TD indicators onto Bloomberg about 6years ago was a tremendous boost as it meant the studies →→

Interview


became readily available to a much wider audience and couldbe applied to a much bigger universe of instruments. Sincethen, Bloomberg, Tom DeMark and the team of peopleworking with Tom (including TJ Demark, Rick Knox andRoderick Bentley), have done a fantastic job of enhancing theTD indicator functionality and user experience. In the past 18 months, Market Studies (Tom’s company), in

association with Bloomberg introduced the TDRS service. Anumber of features have significantly enhanced the value ofthe indicators in my opinion and as people are getting a bet-ter appreciation for how they work, they’re realising thepower of the studies. Specifically, there is an educationalservice called TD Cursor Commentary, whereby the userclicks on an individual price bar to see the interpretation ofthe TD studies applied to that bar. There is also an instantmessaging service on Bloomberg, where Tom and his col-leagues provide real-time educational information about theapplication of the indicators. Lastly, and perhaps most valu-able is a scanning facility. This enables users to scan virtuallythe entire Bloomberg database for TD based signals on mul-tiple time frames. One can even create custom portfolios andlook for signals based on combinations of TD indicators. Ibelieve this functionality is revolutionary and opens up awhole new area of relative value trading opportunities whichwould not have been possible previously.

TA: Is your TA research mainly focused on usingDeMark?

JP: I believe UBS Technical Strategy is unique in the sensethat the group consists of product specialists, (based inLondon, Zurich, Stamford and Singapore), who are eachexperts in their respective areas. Consequently, each memberof the group publishes research (and trade ideas) based sole-ly on their individual methodology. My personal focus isDeMark and the majority of the research that I produce isbased on that in addition to some historical statistical analy-sis. That’s not to say I don’t believe in other forms of analy-sis, quite the contrary – but I do believe there is a limit to thenumber of things one can follow and this particular method-

ology happens to appeal to me and my trading psyche.

TA: To what extent is DeMark used by UBStraders/investment managers and your clients?

JP: I cannot comment on this question specifically for clientconfidentiality reasons, but the number of people who lookat or use the indicators has grown over time. Personally, I ammost encouraged by the number of fundamentally orientedtraders who are starting to incorporate the TD indicators intotheir analysis to improve the efficiency of their market timing– something that was far less prevalent amongst traders 9years ago before I joined UBS.

TA: To what extent is DeMark used in the markets?Bloomberg say that they have around 36,000 users ofDeMark on their terminals. Does this sound accurate?

JP: I couldn’t comment on exact numbers, but given the factthat Bloomberg have roughly 350,000 customers, it’s notunreasonable to assume that roughly 10% of those look atthe TD indicators in some form or another.

TA:: Did any DeMark indicators signal the current crisisin the credit markets/banking stocks?

JP: One of the advantages of TDRS and the scanning func-tionality is that it enables one to follow a large number ofinstruments and look for common macro themes among thesignals generated. I don’t have a stock specific remit as myprimary focus is FX, fixed income and commodities, but itwas interesting to me that there was a confluence of cross-market signals in a number of markets over the summer: abuy signal on the VIX at 16.30 on 15-May, a sell signal in US2 Year yields at 2.9206% on 10-June: a sell signal at 108.18 inUSDJPY on 13-June, a sell signal in the Nikkei at 14,354 on16-June: a sell signal in the Nasdaq Composite at 2,457.7 on17-June, a buy signal in gold at 883.80 on 23-June and a sellsignal in AUDCHF at 1.0011 on 27-July.

“UBS CLIENTS AROUND THE WORLD HAD ASKED FOR EDUCATIONAL MATERIAL COVERING

THE POPULAR DEMARK INDICATORS, SO [THE BOOK] WAS A GREAT OPPORTUNITY TO

ADDRESS THAT DEMAND.”

Interview


Deflated Optimism?

Combining fundamental and technicalanalysis into one strategy bringsimproved risk-adjusted returns, accordingto four Netherlands-based researchers. Intheir study, they measure the economicvalue of information derived frommacroeconomic variables and from tech-nical trading rules for emerging marketscurrencies, based on a sample of 21emerging markets with a floatingexchange rate regime over the period1997-2007, using non-deliverable forwarddata. Specifically, they assess the per-

formance of currency trading strategiesbased on monthly real interest rate differ-entials and GDP growth as well as mov-ing average trading rules and support andresistance levels. They document thatboth types of information can be exploit-ed to implement profitable trading strate-gies. In line with evidence from surveysof foreign exchange professionals con-cerning the use of fundamental and tech-nical analysis, they find that combiningthe two types of information improvesthe risk-adjusted performance of the

investment strategies. The authors alsospeculate that a dynamic weightingscheme between technical and funda-mental information may yield improvedperformance relative to an equallyweighted combination.

De Zwart, Gerben J., Markwat, Thijs D.,Swinkels, Laurens A.P. and Van Dijk, Dick J.C.,The Economic Value of Fundamental andTechnical Information in Emerging CurrencyMarkets(21 2007, 12). ERIM Report SeriesReference No. ERS-2007-096-F&A

FX Strategy: Fundamentals and Technicals

Long-run stock market underperformance after security offerings is awell documented phenomenon and some have conjectured that thispost-issue underperformance might be the result of pre-issue investoroptimism. Researchers from California State University have investigat-ed this by looking at: 1) whether investor optimism is associated withpost-issue underperformance; 2) how investor optimism changes in theone-year period surrounding the security-offering month; 3) whetherinvestor optimism differs between equity issuers and debt issuers; and4) whether such differences affect companies' financing choices. Theirfindings confirm underperformance of debt and equity issuers andfound that the post-issue buy-and-hold abnormal returns are negative-ly associated with pre-issue investor optimism. They found little evi-dence, however, that investor optimism affects companies' financingchoices.

Yi, Bingsheng, El-Badawi, Mohamed and Lin, J. Barry,Pre-Issue InvestorOptimism and Post-Issue Underperformance(September, 23 2008). FinancialAnalysts Journal, Vol. 64, No. 5, 2008

Making the link between behavioural biases at theindividual level and what we see in the marketsremains largely a matter of untested speculation. Ateam of researchers from Erasmus University in theNetherlands has looked at how models can be usedto build stylized representations of individualinvestors and further studied using agent-based arti-ficial financial markets. In this way, agent-based mod-els can bridge the gap between the micro level ofindividual investor behavior and the macro level ofaggregate market phenomena, and can be used as atool to generate or test various behavioural hypothe-sis. In the same vein, Indian investors have recently

been categorized into different personality types andresearchers have explored the relationship betweenvarious demographic factors and investment person-ality. Their results reveal that the Indian investor canbe classified into four dominant investment person-alities – casual, technical, informed and cautious.

Lovric, Milan, Kaymak, U. and Spronk, J.,A Conceptual Modelof Investor Behavior(June 23, 2008). Erasmus Research Instituteof Management - ERIM, Forthcoming. Mittal, Manish andVyas, R. K.,Personality Type and Investment Choice: AnEmpirical Study(September 4, 2008). The Icfai UniversityJournal of Behavioral Finance, Vol. V, No. 3, pp. 6-22,September 2008

Moving averages and trading range break-out rules are the best at exploiting long-term dependencies in financial data,according to Camillo Lento of LakeheadUniversity. His results, based on analyzing

Dow Jones Industrial Average data, sug-gest that the fractal nature of a time seriesleads to dependencies that technicalanalysis should be able to identify andexploit to earn profits. Lento’s researchshowed that moving averages and tradingrange break-out rules were the best at

exploiting these dependencies.

Lento, Camillo,A Synthesis of TechnicalAnalysis and Fractal Geometry - Evidence fromthe Dow Jones Industrial Average Components(September 4, 2008).

CATEGORIZING INVESTORBEHAVIOUR

EXPLOITING FRACTALS

Research Update


MOMENTUM VERSUS REVERSALTwo UK-based researchers have provided evidence from US, UK andJapanese equity markets that returns depend on the size and sign ofprevious price changes. They find support for the idea that investorsdisplay behavioral biases and simultaneously underreact to some typesof events and overreact to others. Their results show that the markettends to reverse after large price changes, while after small pricechanges a momentum type effect is observed.

Hudson, Robert and Atanasova, Christina V.,Short Term Overreaction,Underreaction and Momentum in Equity Markets(July 10, 2008).

Volume SpikesFurther evidence that past price extremesinfluence investors' trading decisions hasemerged from a US-based research team.They show that volume is strikingly high-er when the stock price crosses either theupper or lower limit of its past tradingrange. This increase in volume is morepronounced the longer the time since the

stock price last achieved the priceextreme, the smaller the firm, the higherthe individual investor interest in thestock, and the greater the ambiguityregarding valuation. Volume spikes whenprice crosses either the upper or lowerlimit of the past trading range, then grad-ually subsides. After either event, returns

are reliably positive and, among smallinvestors, trades classified as buyer-initi-ated are elevated.

Huddart, Steven J., Lang, Mark H. andYetman, Michelle,Volume and Price PatternsAround a Stock's 52-Week Highs and Lows:Theory and Evidence. Management Science.

New MomentumRichard Harris of the University ofExeter and Fatih Yilmaz of Bank ofAmerica have developed a momentumtrading strategy based on the low fre-quency trend component of the spotexchange rate. Using, alternately, kernelregression and the high-pass filter ofHodrick and Prescott (1997), they recov-er the non-linear trend in the monthlyexchange rate and use short-termmomentum in this to generate buy andsell signals. According to the authors, the

low frequency momentum trading strate-gy offers greater directional accuracy,higher returns and Sharpe ratios andlower maximum drawdown than tradi-tional moving average rules.

Harris, Richard D. F. and Yilmaz, Fatih,AMomentum Trading Strategy Based on the LowFrequency. Component of the ExchangeRate(August 2008). Xfi Centre For Financial& Investment Working Paper No. 08/04.

INTRA-MONTHLY MOMENTUMPATTERNS Are momentum strategies in the FX markets likely to work consistently through themonth? Not according to a team from the Universities of Exeter and Bristol. In theirpaper, they document a very strong day-of-the-month effect in the performance ofmomentum strategies in the foreign exchange market. For example, for simple mov-ing average based strategies the authors found that the Sharpe ratio is close to zeroduring the first half of the month until day 12, from when it starts to rise sharply,peaking initially around days 13-15, and then again at around days 20-22. The authorsshow that a two-factor model employing conditional volatility and the volatility ofconditional volatility explains as much as 70 percent of the intra-month variation inthe Sharpe ratio. They further show that the seasonality in volatility is in turn closelylinked to the pattern of US macroeconomic news announcements, which tend to beclustered around certain days of the month.

Harris, Richard D. F., Stoja, Evarist and Yilmaz, Fatih,Day-of-the-Month Effects in thePerformance of Momentum Trading Strategies in the Foreign Exchange Market(October 2008).Xfi Working Paper No. 08-05.

All papers are available from the Social Science ResearchNetwork, SSRN, www.ssrn.com

Research Update


EarningsSurprises andMarketSentimentThere is growing evidence in the financeliterature that investor sentiment affectsstock prices. Two researchers from NewYork University have examined whetherstock price reactions to earnings surprisesand accruals vary systematically with thelevel of investor sentiment. They findevidence that holding extreme good newsfirms following pessimistic sentimentperiods earns significantly higher excessreturns than holding extreme good newsfirms following optimistic sentiment peri-ods. Similarly, their results suggest thatholding low accrual firms following pes-simistic sentiment periods earns signifi-cantly higher excess returns than holdinglow accrual firms following optimisticsentiment periods. In addition, they doc-ument that excess returns in the shortwindow around the preliminary earningsannouncements for extreme good newsfirms are significantly higher during peri-ods of low sentiment than during periodsof high sentiment. Overall, their resultsindicate that investor sentiment influ-ences the source of excess returns fromearnings-based trading strategies.

Livnat, Joshua and Petrovits, Christine,InvestorSentiment, Post-Earnings Announcement Drift,and Accruals*(September 1, 2008).

Jason Perl is head of technical analysis at UBS in London, and is well known as one of thefinancial market’s acknowledged experts on the indicators of Tom DeMark. DeMark himselfworks closely with Steven Cohen at SAC Capital in the US, one of the world’s largest hedgefunds. This fact alone lends credence to his work and should persuade those who are highlysceptical 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 thedemand 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. Much of Perl’s book focuses on the TD Sequential indicator, the most popular and widely

used of all the DeMark range. This is a counter-trend signal generator that looks to capturepoints of market exhaustion and reversal – both in uptrends and downtrends. Its popularity isprobably down to the clarity of the signals it generates and the lack of active price analysisrequired by the user: the software generates the buy and sell signals – the so called Setup 9sand 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 thataddresses 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 tosome 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 theindicators. 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 andtrendlines. 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 TDCombo, 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 thenPerl’s book is a well written and essential antidote to this. In addition, Bloomberg’s new rangeof 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.

By Jason Perl Published by Bloomberg Press208 pages ISBN: 978-1-57660-314-7$29.95

DEMARKINDICATORS

All of the above books are available from the Global Investor bookshop at a discount. Please call +44(0)1730 233870 and quote "The Technical Analyst magazine".

Book Review


Principal Trainer

Trevor Neil

Trevor Neil became a commodities trader at Merrill Lynch in the mid 1970’s before going on to work at LIFFE giving technical

analysis support to �oor traders.

In 2000 he became head of technical analysis at Bloomberg where he was responsible for training and technical analysis software development.

Full course details can be found at: www.technicalanalyst.co.uk/training

For further information email: [email protected]

Register online at: www.technicalanalyst.co.uk or call: +44 (0)1483 573150

Course Details

Duration:

Courses are run from 9am to 5pm and include lunch and refreshments.

Who Should Attend:

Traders, fund managers, hedge funds, risk managers, analysts and brokers

The essential technical analysis course providing a thorough grounding in TA techniques for traders and investment managers new to the subject.

This highly regarded 2-day course provides in-depth training in the most e!ective technical trading strategies for more experienced market professionals.

Recognising that portfolio managers and analysts do not need the kind of technical analysis used by day-traders and dealers, this course concentrates on market timing from a longer-term point of view. This course is designed to give a timing overlay for fundamental decisions.

Training Courses

Training with The Technical Analyst

The Technical Analyst o!ers a range of exciting training courses for traders and investment managers. We also o!er specialist in-house training on request.

ADVANCED TECHNICAL ANALYSIS (2 DAYS)

TA FOR THE PORTFOLIO MANAGER

INTRODUCTION TO TECHNICAL ANALYSIS

20/21 November Hong Kong28/29 January '09 London07/08 May '09 Hong Kong13/14 May '09 Stockholm20/21 May '09 London01/02 July '09 Frankfurt

19 November Hong Kong27 January '09 London06 May '09 Hong Kong19 May '09 London

25/56 November London23/24 April '09 London

An in-depth look at these unique market timing tools.

DEMARK INDICATORS

13 November London18 June '09 London

Our very popular course for all market professionals looks at a variety of trading techniques for developing an e!ective short term trading strategy.

SHORT TERM TRADING WORKSHOP (2 DAYS)

03/04 December London20/21 April '09 London

GET QUALIFIED IN TECHNICAL ANALYSIS

For more information on how to join and what is involved in passing

the STA Diploma exam, visit our website at: www.sta-uk.org or call

us on +44 7000 710207

The Society of Technical Analysts (STA) represents and accreditsprofessional and private Technical Analysts operating in the UK

Originally established in the 1960s, the STA provides its members:• Education Monthly lectures and regular teaching courses in technical analysis

• 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

Uses Bloomberg or Reuters codes

Ultra fast scanning and alerting

Unlimited charts on your screens

Libraries full of custom indicators

Make the most of your Bloomberg or Reuters data for a low monthly fee

Program and backtest any strategy

Report writer, logos and notes

Chart all your Excel data

Price targets – Risk Reward ratios

Advanced Trading Tools

Updata Professional version 6.1 out now Download a free trial - www.updata.co.uk

Updata is a registered 3rd Party Application - Bloomberg or Reuters. All trademarks are the property of their respective owners.

Contact us direct: [email protected] Call for a demo: +44 (0)20 8874 4747

Increase the power of your marketterminal

Market professionals in over 30 countries rely on Updata software

GGlobal Sellobal Selll OOffff - The Technical Analyst Perl of UBS talks about DeMark indicators...

Documents

Transcript of GGlobal Sellobal Selll OOffff - The Technical Analyst Perl of UBS talks about DeMark indicators...