Market Technician No 44

Equity markets are tumbling as this issue goes to press and most of the
articles were submitted well before the latest collapse in share prices. No-
one is prepared to call how far the markets will fall in the current
environment but the head and shoulders pattern that has been traced out
on a number of charts looks very ominous. With so much gloom and doom
around, it is perhaps salutary to remind ourselves that bear markets end
when everyone is at their most bearish. Cycle theory also teaches us that
trends do not go on forever and the current bear market has been in place
for two and a quarter years, making it one of the most prolonged
downturns since the great depression. It should also be remembered that
there has been a positive signal on the Coppock indicator and two articles
in this issue focus on this remarkably consistent long term buying signal.
Full credit for spotting the extent of the downturn must go to Peter Beutell
of MTS Research Ltd. who warned us what could be in store in his article
Great Bear Markets and Some Time Targets for a Major Low which appeared
in last Octobers issue of the Market Technician. Peter will be giving us an
update of his view on the market in the next issue.
The October IFTA conference, which this year is being hosted by the STA in
London, looks like being a very successful occasion. You will by now all have
received a brochure about the conference and will have seen that
we have managed to put together a most impressive range of first-rate
speakers. We are aware that it is difficult for some members to put aside
three days to attend a conference and so we have made available a limited
number of day tickets. Further details can be obtained from the website or
by phoning Kate Connors of Concorde Services on 0208 743 3106 who are
helping with the administrative side of the conference. Anyone thinking
of attending should note that the early booking discount ends on
9th August.
* * *
The financial sector has always been well represented north of border. In
recent years the established fund management houses have been joined
by a number of hedge funds. The Scottish Chapter of the Society has
flourished on the back of the increasing use of technical analysis.
Membership has risen steadily, drawing new members from both the
professional and private sides of the market, as well as the academic
community.
The Chapter has been galvanised by Gerry Celayas return to his Scottish
roots. We are endeavouring to hold regular monthly meetings as well as
the now established one-day Scottish Seminar in November. We are very
grateful to Standard Life Investments for the use of their facilities each
month in Edinburgh and we are also hoping to hold at least one meeting in
Glasgow during the summer.
We have been lucky to have had some top class speakers recently who have
covered a broad range of disciplines from orthodox pattern recognition
through to Elliott Wave and the cutting edge of Neural Networks. We have
also hosted a joint meeting with the Society of Business Economists where
the debate was particularly vigorous and enjoyable. Each speaker was
presented with some quality Scottish malt whisky to help them in their
future analysis!
We are keenly aware that members and prospective members would like to
establish local educational courses in Scotland in order to facilitate
preparation for the STA Diploma exam. We are working with John Cameron
and colleagues at a local university and look forward to being able to hold
our own diploma courses in the future.
The Scottish Chapter is always on the look out for anyone interested in
attending or speaking at meetings so if you find yourself in the area around
the third Thursday of each month and want to come along then please get
in touch with Murray Gunn or Gerry Celaya. Details of upcoming meetings
are always posted on the website.
IN THIS ISSUE
STA Exam Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
D. Murrin The physics, behaviour of
markets and the investor . . . . . . . . . . 3
C. Mack Coppock understood . . . . . . . . . . . . . 6
S. Griffiths The simple ABC correction . . . . . . . . 8
Z. Harland Using support vector machines
to trade aluminium on the LME . . . . 9
S. Warner Beat the index using the index . . . 13
R. Marshall The Coppock turns up . . . . . . . . . . . 16
July 2002 The Journal of the STA
Issue No. 44 www.sta-uk.org
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10-12th October IFTA Conference, London
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MARKET TECHNICIAN
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PUBLICATION OF THE NEXT ISSUE
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MARKET TECHNICIAN Issue 44 July 2002 2
STA DIPLOMA EXAM RESULTS
NOVEMBER 2001
PASS LIST
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Issue 44 July 2002 MARKET TECHNICIAN 3
The purpose of this paper is an attempt to instigate a change in your
perceptions of markets and how you interact with them to reach your
goals. To achieve this I shall pose some deep questions and provide some
answers that I have gathered through 15 years of direct experience. I hope
that this information will be applicable in whatever specific approach you
have chosen to involve yourselves in the markets.
My rationale starts by breaking the problem down into basic principals to
develop a model for markets. If we take the essential components of
markets we have the following:
i. A market transaction takes place within the universe and is subject to
all its laws and processes. Therefore, an examination of the laws of
physics that might pertain to the mechanics of a market is essential to
our model.
ii. Next there is the market, which in essence is a process for exchanging
an asset with a group of other human beings that comprise a closed
system.
iii. Finally, there is the investor, a human being and a product of thousands
of years of evolution, with all its prejudices, strengths and weaknesses.
Following this train of thought, I will start with the universe and the five
theories that might apply to markets, as this should help us transact our
business more successfully
1.1 Chaos theory
The recent research into chaos theory has provided an insight into the
essence of order and disorder in nature. The red spot of Jupiter best
exemplifies this, being a gaseous planet in a constant state of change. The
border of the red spot exists within the chaotic gaseous atmosphere that
shows great disorder, and then, within the domain of the spot, the gases
also exist in a state of flux. In short, disorder, order and disorder lie side by
side.
This explains why people and systems, which have attuned to a certain type
of order in the market place, suddenly encounter periods of losing trades.
The key lesson to be derived from this theory is the importance of knowing
when your system is working in the ordered phases and to run the winners,
but when you encounter chaos, to have a methodology to stop trading and
conserve the war chest.
1.2 Fractal theory
The universe shows fractal properties, as described in fractal theory. In
simple terms, this is the repetition of geometry within nature across
different degrees of size. This means that patterns that are apparent on a
small scale are also generated on larger scales within the same system.
Examples of such fractals are:
The distribution of star clusters
The definition of coastlines
The structure of a simple cauliflower
The structures in the human body and brain

Any model that is used in the markets should recognise fractal structures
across different time frames, which allows us to develop short, medium and
long-term time frames.
1.3 Fibonacci theory
This well-known theory, derived from the Fibonacci number sequence,
recognises that there are natural harmonic ratios that exist in nature, the most
applicable to the market being 23%, 38%, 50%, 62% and 76% as a function of
the retracements of moves. However, the essence of applying such a theory
requires us to be able to recognise the inter-relationships of a sequence of
highs and lows before the retracement aptitudes can have any meaning.
As I will explain later, it is my finding that the application of Fibonacci theory
is related to the Elliott wave structure, so wave 2 retraces wave 1 according
to Fibonacci ratios.
1.4 Quantum theory
The current thinking on the universe is governed by the theories of
quantum mechanics, which imply a non-deterministic nature to the
unfolding of events within the time continuum. This 20th century theory
changed the old Newtonian world of predictability to a state of pure
potential and infinite possibility.
Furthermore, as found during the early experiments in particle physics, the
very act of observing an experiment changed the outcome of the
experiment. Thus, awareness of an event changes the outcome of the
universe. In effect, the infinite state of all possibilities of a quantum particle
collapsed into a set entity as soon as it was observed; in other words, the
process of observation was akin to solidifying the jelly of probability.
This is a shattering observation, that the consciousness of the observer
brought the observed into being. Nothing in the universe exists as an
actual thing independent of the perception of it. This applies to all aspects
of our existence, but a particularly pure example is our participation in the
markets, where our internalised model of emotions and expectations are
played out through interacting with the market.
Thus, any model developed that was designed to predict market behaviour
should be best described in the context of a probability field, with each
event being given a probability to its outcome.
1.5 The zero point field
One of the big questions posed in physics over the years has been the
nature of space. Over the centuries, the concept of the ether has waxed and
waned, but the newest concept is the zero point field.
This theory describes the basic sub-structure of the universe as a sea of
quantum fields like the one described in Quantum theory. It is this
revolutionary concept that starts to change our view of the universe, which is
in fact a seething maelstrom of sub-atomic particles popping in and out of
existence, within which sub-atomic waves and information can be propagated.
Why is this significant? Well, it would allow for a faster than light
communication between human beings and, therefore, a mechanism to
share a group consciousness. It further implies that the past, present and
future are all closely entwined in the zero point field and that the universe
is holographic in nature and much, much more!
2.0 The behavioural patterns of markets
Having examined the universe and some of current theories used to
describe our current understanding of its mechanisms; I shall now examine
the human component, primarily you and the market.
The physics, behaviour of markets and the
investor
by David Murrin
This is a summary of a talk given to the Society in February 2002
2.1 The market is a closed system
This means that for every winner there is a loser as there are only a finite
number of people in the market place. This is key as we can assume that on
the basis of natural selection, the most successful predators, or players, live
longer and become bigger. The implications of this are that the success of
a large player would require the failure of many small and medium size
players. As an inexperienced player to the market, the key is to enact a
strategy of learning that allows one to survive long enough to grow bigger.
A closed system like a market needs to be balanced and maintain its
equilibrium of both long and short positions, which is achieved by moving
the price to a balanced position. This starts to explain the process where
patterns in close proximity alternate in form to confuse expectations. For
example, as more than a sustainable percentage of the system believe that
a certain outcome is inevitable, the pattern evolves into a more complex
form to re-assert equilibrium. This phenomenon is seen in Elliott wave
alternation between waves 2 and 4.
This is why simple behavioural or 1st degree patterns will be apparent in
markets that are not sophisticated. However, in more developed markets,
where complex trading systems become the norm, and move to the 2nd
degree, the price patterns should be harder to capitalise on.
2.2 A fishy question
One question that I have always wanted to ask a fish who is a member of a
shoal is:
What is it like to be a part of the shoal, to be sublimated to the group
consciousness and not even be aware of so many choices that have been
made by the group consciousness?
And it is my guess that the fish, if he could, would answer that he had not even
been aware of the influence of the shoals consciousness upon its choices.
2.3 Tribal behaviour
In our current social structure in the western world, it is easy to forget our
tribal origins. In the mid-eighties, I was lucky enough to spend a couple of
years in the swamps of the upper Sepik basin in Papua New Guinea. This
was at a time when the local population had been scarcely touched by
civilised society, living in small tribes of 60 to 200 in a difficult environment.
During his period, I made the following observations:
The emotions of one person could be transferred to the rest of the tribe, so
that one persons anger towards an object outside the tribe could be
resonated in the rest of the tribe.
The tribes emotions appeared to be stored in a similar way to the charge in
a capacitor, with an initial high level of feeling that decayed over a few hours
to a point where the majority of the tribe forgot their original grievance.
This may be the way all human emotion behaves with time, but what was
notable about this observation was that one person could influence so
many with his emotion. The extremity of this behaviour was initially
attributed to a lower threshold of individuality that existed within the tribe
as the result of a small inter-dependent community. However, subsequent
observations on institutional trading floors revealed that similar behaviour
patterns exist in our society and govern the majority of our actions, just as
they did in the jungles of New Guinea.
It is my belief that humankind evolved within a tribal structure, and
developed strong group behavioural patterns. Despite the fact that our
tribes have expanded from small groups into thousands within companies
and millions in countries, these basic behavioural patterns still govern a
large portion of our thoughts and actions.
2.4 Individuality
Despite living in a society that values individuality, we are all, to some
degree, deeply linked to the rest of society and its collective consciousness
by our lower brain functions. Only a few people are able to maintain their
individuality in the face of strong group perceptions and it is these people
who are most suited to directional risk-taking in markets.
For purposes of market analysis, we may conclude that the market has a
collective consciousness that processes information and then responds
predominantly on an emotional basis, reflecting fear and greed. For the
individual, this equates to the fear of losing money, employment and self-
respect and the greed associated with a higher standard of living, freedom
of action and increased self-esteem. Furthermore, as I will later explain, the
dominant thought process within markets at present that comprises this
collective consciousness is the right-eyed, left-brain participant. This has
some important implications as developed below.
3.0 You the investor
Having determined that the market comprises a collection of investors, our
model now requires us to look more closely at the individuals within it and
their decisions.
3.1 Individual thought process and brain development
Understanding the decision-making process starts with knowing the
development and structure of the human brain. In simple terms, the
earliest section of the brain to develop is the stem, which governs the
majority of the bodys basic functions, but was also responsible for
assessing the linkage and acceptability of an individual within a tribe.
This means that each word and action was assessed for acceptability within
the tribe to ensure continued inclusion in the group. One must remember
that, in the early stages of human existence, to be ejected from the tribe was
to reduce ones chances of survival considerably, thus all of our forefathers
would have developed this trait. As a result, the tribe developed a collective
consciousness to which all its members were connected by varying degrees.
Only in more recent history did mans brain develop frontal lobes, allowing
a more sophisticated thought process. However, as a more recent addition
to the brain, they have not had time to develop complete control of our
thoughts and actions and, therefore, the older sections of our brain
dominate and produce highly emotional behavioural patterns that can, at
times, override the thoughts from the higher centres of the brain. Thus
human history has not been governed by the vulcan process of logic, but
prominently influenced by emotional perceptions.
3.2 Style of trading
The majority of market participants are involved in a mechanistic pricing
business and complex structuring of products that rely on spreads for
revenue generation. Only a few are involved in the rather predatory activity
of speculation or directional trading. This area is very demanding and,
within the context of group patterns, there are some important insights
with respect to individual characteristics that facilitate success.
i. Contra entry point trading: where the initiation of the trade is contra to
the prevailing trend, which, if correctly located, is also at the end point
of the trend. From this advantageous entry point the duration of the
trade can be varied across all time frames.
ii. Trend Trading: where the initiation of the trade only occurs a considerable
time after the new trend has commenced. To take advantage of such
trades the duration of the trade has to match the duration of the trend.
This style tends to be that of longer time frame traders.
3.3 Master eye dominance
To those not familiar with a master eye, all of us use one eye more than the
other, and this is the dominant eye. This eye is then cross-linked to the
opposite side of the brain, which governs the principal mode of thinking.
Thus, a left-handed person in 95% of occasions will have a left dominant
eye, and right brain hemisphere dominance in thought process. In our
society, the word sinister meant a left-handed person and, because of
prejudice, many were forced to become right-handed. So it is possible that
people with left dominant eyes are right-handed. These dominance
patterns represent a hard wiring difference in the neurological connections
in and between the two hemispheres of the brain.
It is our theory that these differences in the male brain for a left master eye
confer an advantage in Contra entry point trading, as follows:
i. In practical terms, the use of the right side of the brain confers non-
linearity and creative processes, while the left side of the brain is linear
and logical. As the structure of market predictions is not one of linear
extrapolation but more one of a non-liner creative process, this gives
the right side of the brain an operating advantage.
ii. On the basis that more people are right-handed and use the left side of
the brain, any collective market consciousness described above is more
likely to be based on the left side of the brain, allowing those with left
master eyes to be less affected and more objective in their analysis.
iii. Furthermore, left eye dominance tends to produce a more visual
perception of information, so systems like wave counting are more
easily assimilated.
Conversely, traders with right eye dominance should show a more linear
thought process that is more suited to systematic trend trading.
Ideally the best combination would be enough sensitivity to enter at the
lows, but then to ignore all the shorter term signals and run the trade for as
long as possible to reach the highs. Such a style would require a combination
of both approaches.
3.4 A study of the brain and brain damage
Until I read a recent study of brain damage and recovery rates, I could not
understand why these traits were more apparent in men. The study made
the following observations:
i. Men recovered better than women,
ii. Left-handed men and women recovered faster than right-handed men
and women.
Thus, at the extremes, a left-handed man would have the best recovery rate
and a right-handed woman the worst chances of recovery. The reason for
the differing recovery rates is to do with the number of cross-linkages
between the hemispheres; the greater number of cross linkages in a
woman facilitates greater re-routing of neural connections once damage
has occurred. Conversely men have more polarized hard wiring in their
brains than women, using one or the other hemisphere more actively.
I believe that major decisions should be taken using a combination of skills
and approaches, and Wavecounts services are designed to compliment the
institutionalised thought process, which, by its very nature, will tend to be
right eyed and left brained.
3.6 Bushido zen and enhancing separateness
There is one more important aspect of discretionary analysis the mindset
with which the analyst enters the market place, with and learning to live
under the stresses generated by taking risk on a daily basis.
One interesting example that stands out is the description of a veteran U.S.
8th army bomber crew member in World War 2 who flew missions over
Germany as described in the book Combat Crew by John Comer. He
described his own transition from a combat air gunner to a veteran, when
after 50 to 60 missions, he moved from being a green crew member, with all
the terrors and fears of such an unforgiving and brutal environment and
adjusted to the point where another mission became just part of daily life.
Two lessons are apparent from this example: the first is that humans, if given
enough time, can adapt to the most challenging of environments; and
second, that the adaptation does not take place as fast as we might wish!
In a methodology such as Elliott Wave Analysis, the thought process of the
analyst is vital to the success of the analysis. While a black box system
reduces the emotional connection with the decision-making process, more
discretionary approaches require a method of clearing the mind.
The most important point of this is to remove the emotional aspects of
market involvement, both on the profitable side and on the losing side,
make it as clinical as possible and aim to be in a state of detachment. As
many experiments have now shown, we are more able to influence our
surroundings when we are in such a detached state, as per the theories in
quantum mechanics. Conversely, stress will only strengthen the individuals
susceptibility to the markets behavioural patterns.
Above my desk, I have a picture of a Japanese Bushido warrior, and the most
powerful lesson is, just like the warrior, it does not matter how many battles
you have fought, the next one may be your last if you forget your discipline
and mental process. He must clear his mind before each battle, and his
survival will depend on seeing the world for what it is rather than what he
thinks it is.
Trading is no different.
4.0 Conclusion Why Elliott Wave?
In this paper I have explored the universe and some of the laws that I think
are important in the development of a profitable market model. The form
of analysis that I have chosen that conforms to all of these theories is the
Elliott Wave model. A detailed explanation of how to apply this method
is outside the scope of this article, but a complete guide is given on
www.wavecounts.com. However, to summarise, the key points are:
A closed system alternation, equilibrium and evolution as a

biological system
Chaos theory knowing when you know, chose only the clear
patterns
Fractal theory seen throughout a wave count in different time

frames
Fibonacci requires a wave count to evaluate the interrelationship

between waves
Quantum theory a system that copes with a world of probabilities

and demands a model that ascribes probabilities to the outcome of
different future paths of the market place.
Zero point field the means by which a group consciousness, in this

case a market, is able to communicate instantly across space.
I have also explored the human brain and the effect of markets on
individuals, which, once fully appreciated, can be integrated into ones
model of markets to enhance profitability.
A market is a closed system it is a finite system, with boundary

conditions
Price is the net product of the markets perception of value at any

given time.
A market is a biological entity and acts as a dynamic organism that

has a short and long-term memory and has a degree of self-
awareness of its past and present behaviour. This accounts for
alternation in adjacent corrective structures.
As an investor you need to:
Understand the way your brain is hard wired
Find ways of optimising the way you trade and how your brain
operates
Optimise your separation from the market consciousness.

David Murrin, www.wavecounts.com
The Coppock Indicators buy signals around the start of 2002 on the main
European and U.S. share indices led me to think about the mechanics of the
indicator. It is widely used on Stock Indices, and there is plenty of published
work on its reliable record, when it signalled, and how much markets rose
afterwards. But why might it (or might it not) work as a long-term trend
indicator?
Coppocks original concept was to devise a momentum indicator, with the
period chosen to reflect our period of adjusting to lifes traumas like death
and divorce; this was determined at 11-14 months. Presumably he reasoned
that financial loss following a serious stock market fall (he studied the Dow
index) would be such a trauma, and need a similar period for sentiment to
recover. So he devised the indicator based on monthly prices compared
with their 11-14 months-ago figures. He averaged those periods
momentum figures, then produced a weighted moving average of the
answer. This gave a smoothed indicator with apparently faster response to
more recent months data.
The result is a curve, which cycles up and down over several months, being
visually straightforward with smooth major trends but occasional small
blips. The major turns are the signal points the absolute number of the
indicator is not important. The indicator number will usually (but not
always) swing into negative territory before turning up, and it usually rises
to a positive figure greater than its deepest negative before rolling over
again. Coppock said it must only be used for market recoveries (when the
indicator bottoms), and presumably this is in line with his trauma thinking
a rising market towards a top has a different psychological effect on us, so
he did not deem it suitable for tops. Finally, he said a low-risk buy signal
was given by the indicator turning up from a below-zero reading.
However, some people do use the topping of the indicator as a sell signal,
and also recognise a buy signal when it turns up from just above zero. How
valid might all this be?
Calculating the indicator figure conventionally
Price Coppock used (maybe for ease of calculation in the pre-computer
era) only a month-end figure for the Dow index. Nowadays we can as easily
take averages of weekly or daily closes within each month, to represent a
months index performance better. Whichever representative price is
chosen, the calculation then continues.
Momentum for each month, the price is divided by that of 11 months
previously, and also by that of 14 months previously, and each is expressed
as a percentage increase. The momentum for the month is the average of
these two percentage increases. Some software shortcuts this and just uses
a single 12 month figure. Whichever momentum figure is used, the
smoothing is then the same.
Smoothing The momentum figure is both smoothed using a moving
average, and weighted for more responsiveness to recent months. The
Coppock Indicator is calculated as a linear-weighted 10-month moving
average of the momentum. If, for example, the momentum in month one is
called M
1
, then the indicator number is calculated as the left-hand column
of the table.
Coppock calculated in this way for the FTSE100 in the 1990s is shown
plotted against the FTSE itself on Chart A. One can observe :
the three buy signals from indicator-below-zero were all successful; they
followed extended sideways ranges or triangle patterns in the share
index.
a short sharp correction at the start of 1994 was not enough to trigger a
Coppock turn up; a longer period of consolidation was required first.
using Coppock as a sell indicator, you would have had mixed success
and two failures.
the 1997 buy from indicator-above-zero was successful, if you allowed it

as a signal, though late in an already well-established trend.
for Coppock to reach below zero requires the share index to be below its
previous peaks for an extended time.
Thus far there are no new insights, but the workings of Coppock may be
seen in a clearer light through the following, alternative method of
calculation.
Calculating the indicator alternative method
Whilst most people calculate the indicator by using the full formula each
month, the alternative way is to calculate in full for only the first month to
get a starting number, then add the calculated change each month to get
the next months figure. The Tables column Change in Coppock shows an
interesting result. The Change in the Indicator figure from this month to
next is simply:
next months momentum percentage, minus this months simple
moving average of momentum for the 10 months to date.
This gives us the clue to understanding the Coppock Indicators response:
Coppock turns up whenever the Change becomes positive after
falling. That is, when next months momentum exceeds its 10-month
simple moving average this month. And that is, when momentum cuts
its own moving average from below the classic moving average
crossover signal.
So to find when Coppock will signal buy, you do not need to calculate or
plot the indicator at all merely chart say the12 month momentum of the
share index (the purist will use the average of the 11 and 14 month-end
Coppock understood
By Christopher Mack
This months Coppock Next months Coppock Change in Coppock
1.0 x M11 + M11
1.0 x M
10
0.9 x M
10
-0.1 x M
10
0.9 x M
9
0.8 x M
9
-0.1 x M
9
0.8 x M
8
0.7 x M
8
-0.1 x M
8
0.7 x M
7
0.6 x M
7
-0.1 x M
7
0.6 x M
6
0.5 x M
6
-0.1 x M
6
0.5 x M
5
0.4 x M
5
-0.1 x M
5
0.4 x M
4
0.3 x M
4
-0.1 x M
4
0.3 x M
3
0.2 x M
3
-0.1 x M
3
0.2 x M
2
0.1 x M
2
-0.1 x M
2
0.1 x M
1
-0.1 x M
1
total = indicator for total = indicator for total = M
11
minus
(this) month 10 (next) month 11 0.1(M
1
.....+M
10
)
figures, as Coppock did), superimpose the simple 10-month moving
average of that momentum, and observe the crossovers from below. Chart
B shows Coppock, compared with momentum and its simple10-month
moving average, for the same years as Chart A, to demonstrate this.
Coppocks response now becomes clear:
underlying the Coppock curve is the chart of momentum with its own
simple 10-month moving average. Coppocks signals (turns up or
down) correspond exactly with momentums moving average
crossovers.
the usual features of a momentum chart apply. Momentum may show
definite trends which can be analysed with trendlines; breaches of
trendline slightly anticipate the Coppock signal. Likewise divergences
in momentum vs price give anticipatory signals. Overbought and
oversold levels can also be set for momentum, which may also
anticipate or confirm the moving average crossovers.
a Coppock below-zero-buy results when momentum has been in a
lengthy downtrend and is itself coming up from below zero. The buy
signal itself (at the moving average crossover) occurs near the
conventional buy signal given when momentum crosses up through
its zero line.
a buy-just-above-zero signal comes when momentum has been falling
less sharply and is still above zero. In that sense, the signal is weaker
(less oversold) than a turn up from below zero. Likewise, a turn up from
well above zero is weaker still as a signal.
a deep spike or V-bottom reversal in the share index may be expected
to reverse momentum sharply enough to foreshadow a Coppock
signal as it did in September 2001.
the small blips on the Coppock curve turning down in a rise, then
up again within a month or two are now seen as whipsaws in the
moving average crossover of momentum. It is not the 11-14 month
momentum period which controls this, but rather the 10 month
smoothing and moving average period. With a longer moving average
period there would be less false signals like this but at the expense of
a later crossover signal.
Coppocks Indicator has a smooth curve because he only took a single
month-end figure for price to calculate momentum. All the potential
whipsaws within a month were thereby eliminated but the month-
end figure itself might still produce a whipsaw for a month or two.
These whipsaws represent the 2-3 month intermediate corrections
often present in share and index prices.
To see whether a Coppock turn is potentially a real signal or a
whipsaw, you might therefore wait a month for confirmation. You
might also look for other evidence in the price chart for example, is
there evidence of completion of an Elliott five waves, anticipating a
major correction, or is this only the end of a first or third wave, in
which case a Coppock blip is more likely?
You can anticipate Coppock signals using a more sensitive weekly
chart for momentum, for example a 52-weekly momentum chart
with a 44-week simple moving average. The chart shows momentum
trends, moving average crossovers and whipsaws very well. A monthly
chart of 12-month momentum with 10-month moving average will
be smoother and closely approximate pure Coppock signals. You can
get a feeling for whether momentum has finished trending and is
therefore likely to produce a valid moving average crossover signal.
Chart C is a recent unsmoothed example of FTSE momentum data
which illustrates this. The February 2002 breach of the downtrend
line from the 1999 momentum high helps confirm the Coppock signal
in January; but a breach of the longer-term downtrend line from the
1998 high would help confirm it more strongly. Whether the upward
move will last and for how long is, as always, difficult to predict.
Not valid for downturns?
There remains the question of why the Coppock Indicator might work
better for upward than for downward turns in a share index. In principle,
momentum is symmetrical sell signals should be the converse of buys
momentum crosses over its 10-month moving average from above, and
Coppock turns down.
The answer must lie in the shape of the trends of the price/index chart and
the response of the momentum chart to them. For example, a V-top spike
reversal should be as good a reversal signal from a momentum point of
view as it would be at a bottom. They just dont occur very often at tops. But
a sharp, deep turn-down in price would be one component of a valid
Coppock sell signal. Conversely, a short shallow price correction will stall
momentums rise and may turn it down but is only likely to cause a
Coppock blip. This will be even more likely if the correction is only a small
percentage of the previous wave up, not reaching usual Fibonnacci levels.
The timespan of the price correction is clearly a key factor. If there is a
shallow but enduring price correction in a range, momentum will stall and
its moving average will rise towards it. This will increase the chance of an
moving average crossing from above and hence a Coppock sell. But such
trading ranges must also be examined on a long-term price chart for signs
of whether they portend long-term rises or falls. Again, Elliott may help to
determine the type and degree of correction in a long-term pattern.
Another factor will be the duration of the price correction compared with
the chosen momentum period in Coppocks case, 11-14 months. Brief
inspection of the price chart shows that a price correction lasting at least 11
months and at least 10 per cent in depth seems necessary for a good
Coppock buy signal. FTSE and other main indices display that. If so, it
ought to be true in reverse a good sell signal needs a preceding price rise
of at least that extent and size in the 11-14 month preceding period (not
counting any extended rise before that).
However, upward trends in share indices last longer than downward trends.
If there has been a price rise lasting much longer than the chosen
momentum period, at the end of which the price has flattened out, then the
above condition may not be met. So despite a good overall foregoing rise,
a price high and a Coppock sell signal, momentum may be telling you this
is just a pause in a longer rise. You may get a much better view by looking
at momentum charts for longer periods for example, a 150-week
Continues on page 8
I have been involved in the speculative markets for over 15 years, and one
thing I have learnt, particularly in these days of ever more complicated and
sophisticated analysis techniques, is that sometimes the simple approach to
analysis is all that is needed to be able to uncover some great trading
opportunities. One of the simplest trade formations that I use is the simple
ABC correction. Although this is not a new pattern, I believe that its profit
potential has been largely overlooked recently, mainly due to this simplicity.
A simple, ABC correction is a three swing correction against the main
trend, where the third swing exceeds the price extreme of the first swing
as shown in chart 1 below.
Chart 1
The chart shows how the euro/dollar exchange rate was in a strong
impulsive rally. This was followed by a simple three swing correction, where
the third swing exceeded the low (in this case) of the first corrective swing.
This is a simple ABC correction against the main up trend.
Why is the identification of the simple ABC corrections so important? Well,
once the simple ABC correction is complete, the main trend normally
resumes. If we look at the above example a few days later, we can see how,
once the simple ABC correction was completed, the euro resumed its up
trend moving up to new highs. (see chart 2 below.)
Chart 2
As such, the end of the simple ABC correction represents a great place to look
to enter the market to take advantage of a resumption in the main trend.
However, in the past the main difficulty has been identifying where the
simple ABC correction was most likely to end. This is resolved by looking at
the price relationships of the individual swings within the simple ABC
correction itself. The most common relationship is where the Wave C (third
swing) is equal in price to the Wave A (first swing). Armed with this simple
piece of knowledge, we can anticipate where the price area (Wave C), and,
as such, the entire ABC correction is most likely to end. I term this the typical
Wave Price Target (WPT).
Chart 3
Chart 3 shows how this simple ABC correction ended right in the typical
Wave C WPT support area. Knowing the most likely support area where the
entire ABC correction is most likely to end allows us to enter a trade with a
very small risk, allowing us to be in a very good position to take advantage
of the main trend once it resumes.
We can also look at price relationships between Wave C and Wave B to
obtain narrow price clusters which will help indicate where Wave C is
anticipated to end. However, the most important relationship for projecting
the end of the Wave C is related to the Wave A swing. As such, the price
cluster given by the Wave C = Wave A price swing in is the most important.
In a subsequent article I will show how the simple ABC correction can be
used to identify the start of a strong impulsive swing. In Elliott waves terms,
this means identifying the start of a Wave 3 type swing, which can be one
of the most profitable trades in a complete 5 wave sequence.
Steve Griffiths is the developer of the MT Predictor software program, which is
designed to scan, and automatically identify ABC corrections as well as specific
Type 1 and 2 trades and all of the Elliott wave sequences. For more information,
please visit Steves web site at www.MTPredictor.com
continued from page 7
momentum chart will give you a better feeling of whether momentum is
well overbought, which may also be a pre-condition for a good Coppock
sell signal. It will also give you divergences from price, which are not
apparent from the Coppock Indicator alone.
Conclusion
Though the Coppock Indicator is quite reliable and widely followed, it will
never be a perfect indicator. This analysis shows that it is just a subset of
ordinary momentum, with its success due to judicious choice of the
momentum period (11-14 months) and the smoothing period (10 months).
Coppock signals actually translate into signals from an ordinary
momentum chart with a simple moving average crossover system, using
the same periods. Though the indicator signals buys quite well after
deepish downtrends lasting around a year, chosing different periods may
tune it to give better sell signals for a given market. In any event, a weekly
or monthly momentum chart with a period of at least 11 months can give
much more guidance than Coppock alone, whilst also giving the exact
Coppock signal time at its 10-month moving average crossover point.
The simple ABC correction
By S. E. Griffiths
Abstract
This paper describes and evaluates the use of support vector regression to
trade the three month Aluminium futures contract on the London Metal
Exchange, over the period June 1987 to November 1999. The Support Vector
Machine is a machine learning method for classification and regression and
is fast replacing neural networks as the tool of choice for prediction and
pattern recognition tasks, primarily due to their ability to generalise well on
unseen data. The algorithm is founded on ideas derived from statistical
learning theory and can be understood intuitively within a geometric
framework. In this paper we use support vector regression to develop a
number of trading sub-models that, when combined, result in a final model
that exhibits above-average returns on out of sample data, thus providing
some evidence that the aluminium futures price is less than efficient.
Whether these inefficiencies will continue into the future is unknown.
Motivation
Is it possible to design quantitative trading models that result in above-
average, risk-adjusted returns? The Efficient Markets Hypothesis (EMH) rules
this out as a possibility. This is not surprising; the arguments supporting the
EMH are extremely persuasive (Fama, 1965), none more so than the
contention that any predictable component will be traded out of the
markets by rational arbitragers, rendering them efficient once again.
Few would disagree with the idea that a visible discrepancy in price, for the
same commodity in two markets, would quickly disappear due to the
effects of arbitrage. The reality, however, is that profit opportunities, when
they exist, are not as obvious as the arbitrage argument might suggest.
They tend to be statistical in nature and, though they may represent a
favourable bet, they are not riskless, possibly requiring infinite capital to
remove completely (Zhang, 1999). Moreover, the effectiveness of zero risk
(as opposed to statistical) arbitrage relies on the availability of a perfect (or
close) substitute. This is not always the case.
If we accept that obvious, predictable components will be traded out of the
markets with relative ease then we must conclude that any remaining
inefficiencies, if they exist, are complex in nature to a degree that they are
not easily exploited with methods used by the majority of market
participants
1
. With this mind, we employ a relatively new machine learning
method, support vector regression, in an attempt to extract possible
regularities in the market price of aluminium a market that is arguably
less scrutinized than others such as the stock markets.
Aluminium on the LME
The London Metal Exchange (LME) was established in 1877 and is the
worlds largest non-ferrous metals derivatives market with a turnover value
of approximately US$2000 billion per annum. It is a 24-hour market trading
through a combination of continuous inter-office dealing and open-outcry
sessions at certain fixed time slots during the day. Of this, hedging
represents 75-85% of turnover (Martinot et al., 2000). Aluminium began
trading on the LME in 1978 though it was only in the mid-eighties that the
contract became widely used when the LME price was adopted as the
industry marker price (Figuerola-Ferretti & Gilbert, 2000). At the time of
writing the LME price forms the effective price basis for the international
base metals market.
The LME three month Aluminium futures contract (liquidity is mainly
concentrated in the three month and cash contracts) is a forward contract
between buyer and seller for delivery of 25 tonnes of the metal on a
specified three month prompt date in the future at a specified price. The
majority of positions are closed before prompt by trading offsetting
contracts, replacing delivery obligations with monetary differences,
officially quoted in USD though sterling, euro, mark and yen can be used
for clearing purposes.
The method of trading on the LME differs to that on most standard futures
exchanges partly due to the LMEs close links with the physical metals
industry and its status as a wholesale market (Gilbert, 1996). While initial
and variation margins are called during the term of the contract, profits and
losses are not realised until the contract prompt date or until it is closed out
deemed an advantage to the physical users of the exchange. Moreover,
when a trade is entered it is at the current three month price, however,
when exiting the trade, an adjustment has to be made to take into account
the possible contango or backwardation of the contract which depends on
demand, supply and interest rate factors for contracts in different delivery
periods. This means that the quoted historical three month price being
modelled is not what would be experienced in real-time trading. Whilst it is
important to bear this in mind, it is not a serious problem as the differences
will tend to even out in the long term, with long (short) positions affected
adversely (favourably) in conditions of backwardation and vice versa in
conditions of contango.
Support vector regression
The Support Vector Machine (SVM) is a powerful machine learning method
for classification and regression which is fast replacing neural networks as
the tool of choice for prediction and pattern recognition tasks, primarily
due to its ability to generalise well on unseen data. Although the SVM, as a
learning method, has only recently gained in popularity, the underlying
principles of the algorithm date back to work done by Vapnik in the early
60s (Vapnik & Chervonenkis, 1964; Vapnik & Lerner, 1963) and are based on
ideas derived from statistical learning theory. This recent increase in
popularity is due to advances in methods and theory which include the
extension to regression from the original classification formulation. For a
thorough treatment see (Vapnik, 1998; Vapnik, 1995), the tutorials (Burgess,
1998; Smola & Scholkopf, 1998) and the introduction (Cristianini & Shawe-
Taylor, 2000).
SVM Regression involves a non-linear mapping of an n-dimensional input
space into a high dimensional feature space. A linear regression is then
performed in this feature space. SVMs use the structural risk minimisation
(SRM) induction principle which differentiates the method from many
other conventional learning algorithms based on empirical risk
minimisation (ERM) alone, for example standard neural networks. This is
equivalent to minimizing an upper bound in probability on the test set
error as opposed to minimising the training set error, which should result in
better generalisation. Importantly for practitioners, recently published
research has shown successful application of the SVM methodology in a
wide variety of fields (Barabino et al., 1999; Joachims, 1997; Mukherjee et
al.,1999; Trafalis & Ince, 2000).
The method has a number of advantages over other techniques; the
parameters that need to be fitted are relatively low in number and, unlike
Using support vector machines to trade
aluminium on the LME
by Zac Harland
1
Fundamental and/or traditional technical analysis
other methods such as neural networks, they do not suffer from local
minima. The two main features of SVMs are their theoretical motivation
from statistical learning theory and the use of kernel substitution to
transform a linear method into a general non-linear method, with little
added complexity.
Model design and methodology
There are different approaches when it comes to deciding how much data
to use when designing trading models. One view is that the market is
always changing and therefore one does not want to use data too far back
in history, as there is a danger that much of it will be redundant. The other
approach is to use as much data as is available, reasoning that the only way
to have confidence in the models final results is if it has acceptable
performance over as long a data history as possible. We subscribe to the
latter approach and use the entire available data set.
To tackle the problem we invoke the principle of divide and conquer in that
we start by attempting to build a number of trading sub-models, each using
a different set of input features. These sub-models are then combined with
the intention of creating a final model that is more effective than any one
model used in isolation constituting a type of committee machine.
Transaction costs are not used as a constraint on model selection when
building the sub-models; the rationale being that in some cases strong short
term regularities contained within price, but not tradeable in isolation due
to transaction costs, might be exploitable if derived models are combined
with other longer term sub-models and the use of majority voting methods.
At the final stage, a trading wrapper which takes into account commission,
slippage and order type is added to simulate real trading.
The data used in this study consist of the LME provisional closing price
the daily 5pm close of the second kerb session of the three month LME
Aluminium futures contract, covering the period from 11 June 1987 to 4
Nov 1999
2/3
. Data from 5 Nov 1999 to the present date is excluded from this
study as it is to be used in a final trading meta-model (that may or may not
include the results from this paper) which will require further out of sample
testing. This will help to alleviate the problem of cherry picking the best
models.
The data are divided into training, validation and out of sample sets. The
training period covers 2136 days from 11 June 1987 to 17 Aug 1995, the
validation set 400 days from 18 Aug 1995 to 27 Feb 1997 and the out of
sample from 28 Feb 1997 to 4 Nov 1999, 700 days (see Table 1).
Table 1
Inputs
Finding a good representation of the data to use as inputs and outputs is
very important, especially when building trading models. The objective is to
find a representation that will render the signal (if one exists) more explicit
and/or attenuate the noise component. The number of possible
transformations of price to arrive at potential input candidates is infinite, so
for the sake of simplicity we considered inputs of the form:
X
t
= log (price
t-0
/price
t-N
) , N = 1,...,10 (1)
in addition to associated lags up to a maximum of 10 and, finally, a
proprietary input based on price seasonality derived from initial
exploratory data analysis. Training examples with values beyond the
3j range were clipped and all values were then scaled to zero mean, unit
variance. The number of inputs per model was kept to a maximum of six in
order to limit complexity. Standard log returns were chosen as the target or
dependent variable:
X
t
= log (price
t+1
/price
t-0
) (2)
The objective was to choose input candidates that exhibited correlation to
future changes in price i.e., the target. To do so, a number of techniques to
measure correlation were used including non-parametric correlation,
mutual information and a technique using ANOVA also used in (Harland,
2000a; Harland, 2000b ) which is similar to that originally proposed by
(Burgess & Refenes, 1995). The main criteria was that any correlation
exhibited by a potential input candidate had to be as constant as possible
over the full length of the training set.
The above procedure resulted in multiple candidate SVR input sets which
we restricted in number to ten. SVR was then used to build a model for each
input set. The choice of kernel determines the type of the resulting learning
machine. Common kernel functions include polynomial, radial basis
functions (RBF) and sigmoid kernels. In this experiment we used RBF
kernels which have the form:
K(x, y) = exp
2j
2
(3)
where j
2
is the width of the kernel. The SVM regression method has a
number of tunable parameters that need to be determined by the user: C
a regularisation parameter, e , and in this case the width of the RBF kernel
j
2
. Table 2 shows the values that were tested.
Table 2
To simulate trading the following rule was used on the continuous output
of the SVM:
IF SVM_OUTPUT>0 THEN LONG ELSE SHORT.
A measure of each models performance was calculated over the validation
set by dividing total daily log returns by the daily standard deviation
(similar in nature to the Sharpe ratio). Those parameters that resulted in the
highest value for this statistic were chosen for the final sub-model, with the
proviso that the gradient of the in-sample training performance was
reasonably similar to that exhibited over validation data. The above model
design procedure resulted in ten sub-models. These were combined
together using majority voting to arrive at the actual daily trading signal
see further details below. For the sake of brevity we provide the results for
two of these sub-models in addition to the final model.
Sub-Model 1
Figure 1 depicts the performance over the whole dataset and is based on
trading one contract. The three month aluminium price is re-based to zero
at the start of the period and multiplied by 25 (contract is for 25 tonnes)
and represents the equity stream experienced by buying and holding one
contract. The Cumulative Equity Curve (CEC) represents the profit
gained/lost by following the output of the SVM following the rule; If
output>0 then long else short. Figure 2 shows the performance over the
out of sample data.
2
In order to satisfy concerns regarding robustness we also tested the methodology using official am/pm fixes and gained similar results.
3
Prior to 1988 the data is the P.M. Unofficial price. The start date is the earliest available for CSI data providers.
Set Dates Length
Training Set 11 June 1987 to 17 August 1995 2136 Days
Validation Set 18 August 1995 to 27 February 1997 400 Days
Final out of 28 February 1997 to 4 November 1999 700 Days
sample set
Parameters Values
C 10, 100, 1000, 10000,100000
e 0.1, 0.01, 0.001, 0.0001
j
2
0.001, 0.01, 0.25, 0.5, 0.75
( )
_II
xy
II
2
Figure 1
Figure 2
Table 3
A number of trade statistics for this sub-model can be seen in table 3. The
results are also included for the second half of the in-sample training set to
give a clearer picture of overall performance.
As mentioned above, no transaction costs have been included so the
numbers at this stage should be seen as general statistics rather than real
trading results. As expected, the training and validation results are good.
Most important are out of sample results, which, in this case, exhibit a
generally upward sloping CEC along with a similar winning percentage as
the rest of the data. The CEC is relatively smooth over the whole data set
from in-sample to out of sample, although the average trade figure
decreases somewhat in the out of sample data to $101, from $118 in the
validation set. If we assume transaction costs of $100 per round turn the
model is not tradeable in its current state, however, the results suggest that
it is managing to detect some form of predictable structure in the price of
aluminium and is therefore used in the final model.
Sub-Model 2.
This model uses inputs that were designed to result in longer average trade
duration and higher average trade returns than the previous model. Results
can be seen in Figures 3, 4 and table 4.
Figure 3
Figure 4
Table 4
Model All 2nd Half Validation Out of
Training Training data sample data
Start Date 870611 910716 950818 970228
End Date 950817 950817 970227 991104
No. of Traders 939 469 168 300
No. of Winners 526 252 101 164
Pot. Winners 56 53 60 54
Gross Profit $403,912 $130,287 $46,437 $73,500
Net Profit $191,000 $56,975 $19,925 $30,525
Average Trade $203 $121 $118 $101
Average Winner $767 $517 $459 $448
Average Loser $515 $337 $395 $315
Max. Draw $12,950 $5,675 $4,400 $4,250
Avg. bars in Wins 3 3 3 3
Avg. bars in Loses 3 3 3 3
Avg. bars in Trades 3 3 3 3
Start Date 870611 910716 950818 970228
End Date 950817 950817 970227 991104
No. of Traders 386 164 61 108
No. of Winners 187 73 27 50
Gross Profit $284,450 $79,400 $23,287 $35,350
Net Profit $164,450 $46,625 $10,700 $17,600
Average Trade $426 $284 $175 $162
Average Winner $1,521 $1,087 $862 $707
Average Loser $603 $360 $370 $306
Max. Draw $11,750 $10,575 $4,600 $4,425
Final Model
The final model is the result of combining the ten sub-models, using a
special rule to trade the result. The rule is explained below, the parameters
of which were arrived at via optimising the Sharpe ratio over the in-sample
training and validation sets subject to the constraint that the average trade
was greater than $250 excluding transaction costs.
Majority Trading Rule:
1) Each SVM sub-model output is assigned 1 if >= 0.0 and -1 if < 0.0.
2) The result for each model on each day is then summed, producing a
number representing the majority decision which can range from -10
to 10.
3) A long (short) trade is only taken if this majority is above (below) a
certain (-)threshold. In this case the threshold was 4.
4) Each trade is then held until the majority decision signals a trade in the
opposite direction. This results in what is commonly called a stop &
reverse system and is always in the market.
Figure 5
Figure 6
The results can be seen in Figures 5, 6, and in table 5. Slippage & transaction
costs of $100 per trade, that is per round turn, are included.
The results are encouraging; the Sharpe Ratio for the training and validation
sets is just over 1.6, rising in the out of sample period to 2.0 (the Figure of
1.41 for the second half on the training data was due to a higher than
average standard deviation of returns). It has an average trade of $258 and a
maximum drawdown (MD) of $4725 on the out of sample data. A more
sobering $14,900 MD occurs at the beginning of the training period from 19
Oct 1987 to 17 Dec 1987 during the stock market crash of the same year.
The average trade in the validation set is $175, lower than both the training
and out of sample sets. At the start of the training data in Figure 5 the CEC
exhibits a sharp rise and then has a relatively constant gradient from the
early-nineties to the end of the data. One possible explanation is that the
market was less efficient at the start of the period, though this is by no
means certain. There is a flat period from 8 Mar 1995 to 18 Jun 1996, which
would be difficult to trade through, however, the fact that it occurred in the
training period suggests the model is not overfitting to any great extent.
Table 5
No trade exit strategy has been incorporated such as stop loss exits, profit
limits etc., as their addition did not result in any discernable improvement.
We find this to be generally the case with trading models of this type
probably due to the model signal itself indicating the ideal time to exit a
trade. Having said that the final trading system would have emergency
stops placed at a distance where they would only be hit in extreme price
moves whether they would be filled at that level is another matter.
Conclusion
An effective methodology has been developed for the application of
support vector regression to trade three-month Aluminium futures on the
LME. Ten sub-models were designed and then combined using a majority
voting trading rule to obtain a final model that, as a first attempt, exhibits
profitable performance over out of sample data. This suggests that the three
month aluminium price contains inefficiencies that can be exploited using
machine learning. Combining the Final Model with other models built by the
author using different methods should result in a usable trading system for
aluminium futures. Of course, there is no guarantee that the relationships
detected over the time period analysed will continue into the future it may
be that these inefficiencies have been traded out of the market.
Acknowledgements
It is a pleasure to thank Terence Roopnaraine, Martin Sewell and Paul Teetor
for useful discussions and corrections.
Zac Harland, Krueger Research
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Burges, C.J.C. (1998). A Tutorial on Support Vector Machines for Pattern
Recognition . Data Mining and Knowledge Discovery, 2(2):1-47.
Burgess, A.N. & Refenes, A.N. (1995). Modelling Non-linear Cointegration in
International Equity Index Futures. Neural Networks in Financial
Engineering (Proceedings of the Third International conference on neural
networks in the Capital Markets 1995). World Scientific.
Continues on page 15
Start Date 870611 910716 950818 970228
End Date 950817 950817 970227 991104
No. of Traders 369 162 75 98
No. of Winners 203 76 41 58
Gross Profit $280,450 $78,537 $29,762 $46,550
Net Profit $172,250 $38,675 $13,125 $25,325
Sharpe Ratio 1.64 1.41 1.61 2.01
Average Trade $466 $238 $175 $258
Average Winner $1,381 $1,033 $725 $802
Average Loser $651 $463 $489 $530
Max. Draw $14,900 $7,175 $6,600 $4,725
After years of searching for an investment/trading methodology which is
both fully automated and able to beat the stock market, we developed and
settled upon the Balance of Sentiment System (BoSS).
While much of Warner Princes equity, bond, currency and commodity
market research has historically utilized price momentum as the primary
driver of automated buy/sell signals, we felt we could improve our results.
Late in the 1970s we hit upon a combination of daily New York Stock
Exchange breadth statistics which worked quite well, but there were
several drawbacks. First, we did not have a computer; so we had to hand
calculate our formula from all the numbers which was quite tedious.
Second, we learned that there was tremendous volatility in the end result
of the formula, and, having not started our charts on semi-log paper, found
it took an enormous height of graph paper on the wall to keep the charts
up-to-date. Frequently, we found ourselves standing on chairs to post new
plots on the charts. Looking back on it now from our state-of-the-art P.Cs, it
seems completely ridiculous. Such is the life of an independent,
undercapitalized research firm.
The lack of a computer made it virtually impossible to sample large
amounts of historical data; so we were stymied in trying to back-test our
formulas to determine their long-term veracity.
With the advent of the desktop computer in the early 1980s we obtained
graphic software first for our Apple IIe and then for our IBM P.C. and, in the
early 1990s, we came upon SuperCharts, which has served us well ever
since.
Several years ago I had some spare time to do more research. I felt I really
wasnt getting anywhere until one night I suddenly awoke from a dream with
what I thought was the answer and immediately wrote down the idea that
would keep the volatility within a useable range. The next day, after some
considerable tussle with my maths and the programming language I was able
to produce what is now known as the Balance of Sentiment Signal or BoSS.
BoSS simply measures the difference between buying pressure and selling
pressure as indicated by breadth statistics. When BoSS crosses the
threshold on the upside it gives a buy signal and a sell/sell short signal on
a cross to the downside.
Chart 1
It was immensely satisfying when, without any tweaking or testing
whatsoever, I applied the formula to fifteen years of daily New York Stock
Exchange data and discovered that to December 29 2000, 51% of the trades
had been profitable, the average gain per trade had been 2.04x the average
loss, and the model had reaped 917.18 NYSE Composite Index points profit,
versus the bought and held indexs gain of 553.94 points without any
short sales!
1
Chart 1 shows the market index with signals (1=buy;0=sell) and the daily
Balance of Sentiment plot over the last three years of this period. It also
graphs the cumulative results as System Equity.
Table 1 shows the quantitative summary of the activity and results over
those 15 years.
Chart 2 brings results up to the date of writing this paper. Note that since
December 29, 2000 the index has been in a bear market, dropping from
656.85 to 581.14 or by 75.71 points (-11.5%), but BoSS profit has been
24.07 points (+3.7%).
Despite this success, one problem to using this research is that over the
past 17 years period the model has made 906 trades, or slightly more than
one a week. This is no problem for traders, but for me and my accounts who
are not fast traders, it is too much action.
2
Since the BoSS model uses
statistics for the exchange as a whole it is best applied to trading certain
broad market indices. Our NYSE BoSS model is most applicable to trading
the very broad NYSE Composite Index. It works, but not quite as well on the
S&P 500 and DJIA. Nonetheless, there are several derivatives available to
trade the NYSE Composite Index.
We have also applied BoSS to NASDAQ statistics with outstanding results.
Again, the problem from our perspective being too many trades, we slowed
things down using moving averages. We back-tested various lengths of
moving average together with various hurdle and trip levels. In the final
analysis, profits were best when the moving average BoS has to climb over
a .7 reading before it will give a buy signal and drop below -3.2 before it will
give a sell signal.
Beat the index using the index
By Seth Warner
1
Past performance is not necessarily indicative of future performance.
2
The BoSS models results assume that all trades are made at the closing price on the day of the signal and do not deduct commissions, which under the right circumstances in the
U.S.A. have become almost negligible.
Table 1
BoSS System on the NYSE Composite Index 3/19/1985 12/29/2000
Gross Profits 1737.08
Gross Losses 819.90
Net Profit 917.18
Total # Trades 835
Number of Profitable Trades 425
Number of Losing Trades 410
Percent Profitable 51%
Average Profitable Trade 4.09
Average Losing Trade 2.00
Ratio avg. profit/losing trade 2.04 to 1
Average # days profitable trades held 4
Average # days losing trades held 1
Chart 2
Chart 3 presents the results of this application over the past ten years and
shows the moving average which triggers the buy/sell signals.
Chart 3
During the period October 6, 1992 to April 24, 2002, the number of trades
on the slowed NASDAQ model was reduced to about 7.6 a year, and 55%
have been profitable. The all trades win/loss ratio has improved to 2.59 to 1.
The model has taken out 3,753.15 index points of profit vs. 1,142.79 for the
index itself. System Equity shows that it has not lost money in this bear
market.
Throughout the part of our research career that has been centered on
timing market indices rather than individual stocks, we have been the
subject of some criticism. People would say you cant trade the market.
Wed say we know that but, just as youll cover more ground flying with
the wind at your back rather than in your face, you will want to be long
most stocks in a bull market and out of most stocks in a bear market.
Now that there are highly liquid exchange traded funds (ETFs) which mimic
most important indices, our research can be directly applied to markets as
a whole, and we have begun managing funds employing the BoSS models.
Some of the ETFs are highly liquid. For example, QQQ (the NASDAQ 100
Trust, a quasi proxy for U.S. hi-tech companies) has been trading in excess
of $2 billion a day for some time and is now one of the most actively traded
stocks in the world. Chart 4 shows our smoothed BoSS on QQQ since June
4, 1999
3
.
Chart 4
Table 2 presents the date and price of each trade and the cumulative profit.
Table 2
BoSS System on QQQ NASDAQ 100 Trust 6/4/1999 4/24/2002
Date Action Price Entry P/L Cumulative
Profit
06/04/99 Buy 52.56
06/14/99 Sell 50.80 -1.76 -1.76
06/16/99 Buy 54.21
07/26/99 Sell 55.88 1.67 -.09
08/20/99 Buy 57.97
09/22/99 Sell 62.59 4.63 4.53
10/07/99 Buy 63.09
10/15/99 Sell 59.88 -3.21 1.32
10/29/99 Buy 65.75
03/17/00 Sell 110.81 45.06 46.38
05/03/00 Buy 89.13
05/05/00 Sell 91.50 2.37 48.75
06/07/00 Buy 94.00
06/23/00 Sell 92.00 -2.00 46.75
06/30/00 Buy 93.44
07/05/00 Sell 91.38 -2.06 44.69
07/12/00 Buy 97.25
07/24/00 Sell 95.00 -2.25 42.44
08/15/00 Buy 93.00
09/12/00 Sell 91.25 -1.75 40.69
11/02/00 Buy 82.25
11/07/00 Sell 82.50 .25 40.94
01/09/01 Buy 57.13
02/05/01 Sell 61.50 4.37 45.31
04/17/01 Buy 41.25
3
This is the same as the model run on the NASDAQ Composite for the past ten years.
Table 3 summarizes signals on the NASDAQ 100 Index between 4/6/1999
and 24/4/2000.
One can easily see that over the above period BoSS has been wrong more
than it has been right but, as successful traders say, it has tended to cut
losses quickly and let profits run. From its sell signal near QQQs peak in
March 2000 at 110.81, QQQ itself has lost 74.17 points or 66.9%. The BoSS
model has actually made 4.03 points during this period without ever
selling short.
Given the still significant number of trades, the BoSS models are most
appropriate for U.S. tax exempt or off-shore accounts. Our more
aggressive models, which also go short and about double the results of
the long only models, are best suited to aggressive off-shore accounts
and hedge funds.
Seth C. Warner, MSTA, is President of Warner Prince Incorporated, Litchfield, CT,
U.S.A., which has provided technically based research to institutions and
managed private client accounts since 1975.
SuperCharts is a registered trademark of Trade Station Group, Inc.
sm Balance of Sentiment, Balance of Sentiment System, and BoSS are
servicemarks of Warner Prince, Incorporated
Copyright, Warner Prince Incorporated, April 25, 2002
continued from page 12
Cristianini, N. & Shawe-Taylor, J. (2000). An Introduction to Support Vector
Machines: And Other Kernel-Based Learning Methods, Cambridge
University Press.Fama, E. F. (1965).The Behavior of Stock Market Prices.
Journal of Business 38:34-105.
Figuerola-Ferretti I. & Gilbert C.L. (2000). Has Futures Trading Affected
the Volatility of Aluminium Transactions Prices? AEA International
Conference on Industrial Econometrics, Luxembourg City, July 5,6 and 7,
2000.
Gilbert C.L. (1996). Manipulation of Metals Futures: Lessons from
Sumitomo. CEPR Working Paper.
Harland Z. (2000a). Using Nonlinear Neurogenetic Models with Profit
Related Objective Functions to Trade the US T-bond Future. In
Computational Finance 1999 (Proceedings of the Sixth International
Conference on Computational Finance). Leonard N. Stern School of
Business, New York University, January 6-8, 1999. Edited by Yaser S.
Abu-Mostafa, Blake LeBaron, Andrew W. Lo, and Andreas S. Weigend,
327 342, MIT Press, Cambridge, MA.
Harland Z. (2000b). Trading a 2 Year Old the Real-Time Performance of a
Neurogenetic T-bond Futures Trading System. The Market Technician,
Journal of the Society of Technical Analysts. 38, 14-15
Joachims, T. (1997). Text Categorization with Support Vector Machines.
Technical Report, LS VIII Number 23, University of Dortmund.
Martinot, N., Lesourd J., Morard B. (2000). On the Information Content of
Futures Prices Application to LME Nonferrous Metals Futures. AEA
International Conference on Industrial Econometrics, Luxembourg City,
July 5,6 and 7, 2000.
Mukherjee, S., Tamayo, P., Slonim, D., Verri, A., Golub, T., Mesirov, J.P. & Poggio,
T. (1999). Support Vector Machine Classification of Microarray Data. AI
Memo 1677, Massachusetts Institute of Technology.
Smola, A. & Scholkopf, B. (1998). A Tutorial on Support Vector Regression.
NeuroCOLT2 Technical Report Series, NC2-TR-1998-030.
Trafalis, T.B. & Ince, H. (2000). Support Vector Machine for Regression and
Applications to Financial Forecasting. Proceedings of the IEEE-INNS-
ENNS International Joint Conference on Neural Networks (IJCNN00).
Vapnik, V. (1998). Statistical Learning Theory. John Wiley & Sons.
Vapnik, V. (1995). The Nature of Statistical Learning theory. Spring-Verlag,
New York.
Vapnik, V.N. & A.Y. Chervonenkis (1971). On the Uniform Convergence of
Relative Frequencies of Events to their Probabilities. Theory of
Probability and its Applications 16(2), pp. 264281.
Vapnik, V. & Chervonenkis, A. (1964). A Note on One Class of Perceptrons.
Automation and Remote Control, 25.
Vapnik, V. & Lerner, A. (1963).Pattern Recognition Using Generalized Portrait
Method. Automation and Remote Control, 24.
Zhang, Y. (1999).Toward a Theory of Marginally Efficient Markets. Physica A,
269, 30-44.
Table 2 Continued
Date Action Price Entry P/L Cumulative
Profit
05/18/01 Sell 48.04 6.79 52.10
05/21/01 Buy 51.05
05/30/01 Sell 44.43 -6.62 45.48
05/31/01 Buy 44.73
06/08/01 Sell 47.35 2.62 48.10
08/01/01 Buy 43.10
08/06/01 Sell 42.50 -.60 47.50
10/08/01 Buy 31.86
10/30/01 Sell 33.38 1.52 49.02
10/31/01 Buy 33.90
12/13/01 Sell 39.76 5.86 54.88
12/14/01 Buy 40.11
12/20/01 Sell 38.79 -1.32 53.56
12/27/01 Buy 40.01
01/16.02 Sell 38.78 -1.23 52.33
03/06/02 Buy 37.60
03/20/02 Sell 36.06 -1.54 50.79
03/21/02 Buy 37.02
03/22/02 Sell 36.64 -.38 50.41
Table 3
BoSS System on QQQ NASDAQ 100 Trust 06/04/1999 04/24/2002
Gross Profits 75.13
Gross Losses -24.72
Net Profit 50.41
Total # Trades 22
Number of Profitable Trades 10
Number of Losing Trades 12
Percent Profitable 45%
Average Profitable Trade 7.51
Average Losing Trades -2.06
Ratio avg. profit/losing trade 3.65 to 1
Average # days profitable trades held 24
Average # days losing trades held 8
After falling steadily for 25 months the IRC Coppock Indicator has turned up
and given a major buy signal for UK equities. The last buy signal was in 1995
following which the FTSE All-Share Index rose over 75% to its peak in 1998.
How much weight should we give to this signal? Given its track record, a
great deal.
So what is the Coppock and how does it work? The Coppock indicator was
conceived by a Texan, Edwin Coppock, who, the story goes, was approached
by the Episcopalian church and asked to devise a system which would
disregard short term fluctuations in the market and provide long term buy
signals. The church funds could then be invested just when the
stockmarket was due for a significant rise.
Coppock came up with an indicator which uses a weighted momentum
calculation to establish major turning points in markets. It was apparently
based upon the amount of time it takes to get over a bereavement, which was
judged to be between 11 to 14 months. After this, optimism could return.
Edwin Coppock founded the Trendex Research Organisation in San Antonio
where they published his timing indicators. Sadly we understand that
Trendex stopped publishing in the 1980s and Coppock himself died in 1989
aged 83. However, his indicator lives on still giving signals, and has
remained one of the most reliable long term buy indicators for both Wall
Street and the FTSE All-Share.
The IRC Coppock is based on the weighted percentage changes of the FTSE
All-Share Index monthly average over a twelve month period. The
weighting ensures that progressively more emphasis is placed on the most
recent months. Buy signals are given when the indicator turns up after
falling below the mean line (in this case 1000). Sell signals for the Coppock,
i.e. when the indicator turns down, are not so reliable and should therefore
be ignored, however, most major bear markets, including the recent one,
have been signalled by this indicator.
Tracing the Coppock back on the Dow Jones Industrial Average to 1901 on
our copies of the Trendex charts, reveals 30 buy signals during the past 100
years (assuming 3 additional buy signals since 1988 when our records from
Trendex ceased).
Of the 30 buy signals, only three failed to work and produce a subsequent
rise on the Dow, being 1901, 1914 and 1941. Notably the last two were
when there was a world war. A buy signal in 1947 produced only a minor
advance and a sideways trading range followed until another buy signal in
1949 resulted in the usual bull market run. Also in 1911 and 1938 as war
approached there was only a small rally. All the other 24 signals were
subsequently followed by strong advances in the next year or two.
This outstanding track record has also been seen on the FTSE All-Share
Index when the IRC Coppock gives a buy signal. Using a strict rule of
calculation, six of the previous eight buy signals on the IRC Coppock since
1965 produced a rise of not less than 16% on the monthly average of the
All-Share Index before the Coppock turned down again. 1965 and 1991
were exceptions, but interestingly the latter of these was also at the time of
war the Gulf War.
On many occasions, of course, the index eventually rose significantly higher, as
between 1995 and 1998 and we have not included 1980 and 1992 when the
indicator turned up as it touched the mean line (rather than turning up from
below it). Including these in the calculations gives an average rise of 32%
on the All-Share monthly average
following an IRC Coppock buy signal.
One of the interesting features of
the recent buy signal, given in
March 2002, is that the indicator
had fallen to its lowest level since
1975 and therefore a strong rally
could be anticipated from this
oversold position.
Over the years the IRC Coppock has
been a reliable indicator for calling
the UK equity market higher.
Since 1965 it has signalled every
significant bull market move. As in
the past, there is no guarantee that
the current signal will subsequently
result in another major bull market
but, given its excellent track record,
when a buy signal is given on the
Coppock, it is worth sitting up and
taking note.
Richard Marshall,
Senior Technical Analyst
Investment Research of Cambridge
The Coppock turns up
By Richard Marshall
Buy Signal Date
IRC COPPOCK INDICATOR
Buy Signal Analysis
October 1965
July 1967
June 1970
February 1975
April 1977
November 1988
March 1991
May 1995
March 2002
Equivalent on
FTSE 100 Index
104.4
106.6
125.7
125.3
179.8
933.5
1193.0
1632.5
2557.4
5271.8
109.5
166.8
224.2
167.8
223.1
1204.0
1266.2
1889.7
(3350.2)
(6906.0)
+5%
+56%
+79%
+34%
+24%
+29%
+6%
+16%
(+31 average
rise)
10 months
15 months
23 months
13 months
10 months
15 months
11 months
13 months
FTA All-Share
Index at beginning
of the following
month
Subsequent high
of FTA All-Share
monthly average
before next sell
signal
% rise
Time until next
Sell signal

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