INDICATOR INTERPRETATION LESSONS
This special segment on indicator interpretation will be featured periodically as a part of the Daily Electronic Worden Report. In this segment we will feature specific individual stocks along with specific indicator parameters. We will predominantly be using our Time Segmented Volume (TSV) and Balance of Power (BOP), but at times we will also try to incorporate other indicators into the mix, such as MACD and stochastics.
Utilizing the TeleChart program, we will essentially take you 'back in time'. This will enable you to see exactly how the charts and indicators appeared just prior to significant price moves in the stock
The stock we are going to start working with today is Digital Equipment (DEC). This company was bought out by Compaq Computer so is no longer listed but it is used here as an example only.
Let's begin by pulling up a daily chart of DEC and clipping it all the way back to 12/3/90. Now let's take a moment and set-up a few indicator modules that we intend to use with this chart. For the purpose of these examples, we will suggest specific colors for each indicator parameter.
Indicator Module #1) - On a daily chart with a zoom=4, calculate a MACD of 9 & 21 (YELLOW LINE) with a moving average of 10 (HI RED DOTS). Moving Average Type = Exponential.
Indicator Module #2) - On a daily chart with a zoom=4, calculate a Time Segmented Volume (TSV) of 18 (HI RED) with a moving average of 10 (YELLOW DOTS). Next calculate a price moving average of 30 (HI WHITE DOTS). Moving AverageTypes = Simple.
Indicator Module #3) - On a 2-day chart with a zoom=4, calculate a price rate of change of 14 (HI GREEN) with a moving average of 10 (HI WHITE DOTS). Moving Average Type = Simple.
There is one more rather interesting, but somewhat complicated indicator module that we would like to share with you since it seems to work well with this particular stock as well as others. However, in the interest of time and space, we will have to save it for our next installment.
Now let's get to the business at hand. Pull up your daily chart of DEC with indicator module #1. Remember, the ending date on your chart should be 12/3/90. There are three things to look at when using this indicator. First, the relationship between MACD (yellow) and its moving average (hi red dots). Secondly, the relationship of both MACD and its moving average to the zero-line. And last, but certainly not least, look for contradictions between price and the indicator. In other words, look for simple positive and negative divergences between MACD and price.
Notice that back in mid-June of 1990 as price had already begun to top out, MACD is below its moving average and breaking down below the zero-line. Just days later, MACD's moving average (hi red dots) also breaks below the zero-line. Now granted, this occurs with the stock selling at about 85, when just a month before DEC was trading up around 95. Which is to say that MACD is more of a lagging indicator, as opposed to one that typically leads price.
As price declines through July, August, and September, MACD (yellow) actually crosses up through its moving average (hi red dots) on a couple of occasions. However, these crossovers are of no real technical value, when one considers they are occuring within the context of a clear-cut downtrend. In fact, MACD and its moving average do not finally hit their ultimate lows until late September. If you were to use this chart exclusively to determine a potential bottom, the first real signs of any positive technicals do not really start popping up until mid- November. It is at this point that positive divergences of some real substance begin to form. It is also at this point that MACD and its moving average break up through the zero-line for the first time in five months.
In Friday's report we were working with a daily chart of Digital Equipment (DEC) clipped back to 12/3/90. You will recall that we outlined three different indicator modules for the purpose of this example. We've just about covered everything pertinent to Module #1, so let's move on to Indicator Module #2.
The interpretion of Time Segmented Volume (TSV) is similar to the MACD discussed in our previous report. As is the case with MACD, we are looking for zero-line crossovers combined with either positive or negative divergences between price and TSV.
On our daily chart of DEC, you will notice that price dropped below its 30-day moving average (HI WHITE DOTS) during the middle part of June -- right around the same time TSV and its moving average broke down below the zero-line. Both are indications of a change taking place in the character of the trend. As a result, DEC's price declines from around 85 to a low of about 45 over the following four months. During which time, TSV remained well into negative territory, flatly refusing to contradict the action in price. This is to say that during this period from June through October, TSV did nothing more than simply confirm the downtrend intact. It is not until the later part of October before TSV (HI RED) crosses back above the zero-line into positive territory. This is an early sign of a change in character. Just as TSV alerted us to technical deterioration taking place back in June (1990), by 12/3/90, TSV was signaling that a short to intermediate term bottom was likely forming. Both of the latest two price pullbacks, coming in early and late November, failed to push TSV below the zero-line. The backing-and-filling action during October and November was accompanied by a TSV showing first, a pronounced dry-up in selling pressure and second, an actual changeover to accumulation.
Now let's look at Indicator Module #3 on both a daily and 2-day chart of DEC. We threw in this rather simple measure of price rate of change (ROC) because we feel its one more pretty good thing to use in order to gain confirmation on conclusions already drawn from the use of other technical indicators. On both the daily and the 2-day chart of DEC, the ROC merely confirms our TSV and MACD indicators.
Using shorter term time frames (i.e. daily and 2-day charts), one is able to detect changes in trends sooner. However, since short-term indicators also tend to produce far more whipsaws, 3-day and weekly charts are vital in determining the direction and the overall health of the primary trend. The primary trend is really nothing more than a stock's intermediate term bias.
We were last working with a chart of Digital Equipment (DEC), updated through 12/3/90. In this example, we are going to demonstrate an easy-to-interpret, short term trading method using only two different indicators. Now remember, these indicator parameters and this specific method of application is not going to work for every stock in every situation. Furthermore, we are out to capture short term, short-lived price swings, with little or no regard to the stock's primary trend. This typically means there will be a greater tendency for whip-saws...so be careful.
Pull up a daily chart of DEC and clip-back the ending date to 2/23/90. Now let's create two different indicator modules to be used in conjunction with each other. For the first one, set-up a daily chart with a zoom=5. Calculate a Time Segmented Volume (TSV) of 21 (HI RED) with a moving average of 10 (HI WHITE DOTS). Average Type = Simple.
Construct a second indicator module on a 2-day chart with a zoom=5. Calculate a Price Rate of Change (ROC) of 18 (HI GREEN) with a moving average of 10 (HI WHITE DOTS). Average Type = Simple
The object here is to buy long and cover shorts when both the TSV (HI RED) and the ROC (HI GREEN) are simultaneously above their respective moving averages (HI WHITE DOTS) and conversely, closeout longs and establish shorts when both indicators are below their respective moving averages.
To start, let's pull up our first indicator module (TSV on a daily chart). Now we're going to scroll ahead, one day at a time using our right bracket key <]>. Each time we advance one single trading day, we are going to check our TSV for a crossover of its moving average. A legitimate crossover would prompt us to check our second indicator module (Rate of Change on a 2-day chart) for a confirmation.
Scrolling ahead just two days to 2/27/90 produces a positive crossover in module 1, but NOT in module 2. Therefore a buy signal does not yet exist. In fact, our first buy signal is not generated until 3/12/90 at 78 1/8. Why on this particular day? Because our TSV and ROC are both trading above their respective moving averages. Now let's slowly scroll forward, one day at a time, closely watching for crossovers in the other direction.
On 3/29/90, module 1 falls below its moving average, but just barely. Checking module 2, we see that no violation has occured. The following day on 3/30/90, both module 1 and 2 are dangerously close to negative crossovers, but are simply not decisive enough to constitute a sell signal. Moving ahead one more day we see that on 4/2, module 1 is just below its MA, but module 2 is at best, ambiguous. Still no sell signal. On 4/6, TSV again breaks below its MA, but module 2 still fails to confirm the negative. On 4/17 and 4/18, module 1 again indicates a negative condition, but module 2 again fails to confirm. The buy signal generated on 3/12/90 at 78 1/8 still remains in force.
Finally on 6/1/90, both indicator modules confirm a negative crossover, thereby triggering a sell signal at 91 3/4. This means we would closeout our long position and take profits right here, while also establishing a new short position.
On 7/9/90, almost six weeks into our short trade, module 1 registers a negative crossover, but module 2 fails to confirm. Continuing to scroll forward one day at a time, we see DEC's stock price plunge to a low of 67 3/8 by early August. Scrolling ahead further to 8/20/90, we see that module 1 is turning positive, but module 2 still indicates a sell. In fact, over the course of the next three weeks module 1 continues to trade above its moving average, but module 2 stubbornly fails to confirm this positive action. We continue to hold our short position. By the end of September, DEC has fallen to a price low af about 50. Remember, we established a short position at 91 3/4 back on June 1, and we're still in the trade
Pull-up a daily chart of DEC with indicator module number 1. Clip it back to 10/2/90. You will recall we are still in a hypothetical short trade, which we entered four months earlier on 6/1/90.
Looking at module 1 on our chart through 10/2/90 we see that TSV has again crossed up through its moving average. However, a quick glance at indicator module 2 shows us that our rate of change indicator is NOT offering a bullish confirmation. Therefore, our short trade remains in force. Scrolling ahead one day at a time, we see that by 10/15, DEC has fallen to a low of
45 1/2. If we scroll ahead just a bit further to 10/22/90, we get our first real look at definitive crossovers by both modules 1 & 2. Since initiating the short trade on 6/1/90, this is the first time that the indicators in both modules are trading decisively above their respective moving averages, simultaneously. In fact, the TSV of 21 in module 1 is actually crossing into positive territory for the first time since June. Based on the rules we have established for using our two indicator modules, it is at this point we would closeout our short trade and establish a long position.
Alright, so we're long DEC as of 10/22/90 at a price of 51 3/4. Now let's scroll ahead several days to 10/31/90. DEC is at 47 1/2 and module 1 has completed a negative crossover, but in checking module 2 we find no clear-cut confirmation. If you scroll ahead through the next couple of days, you will find that module 1 continues to flash a sell, but module 2 fails to confirm. As a result, we hold our long position.
Module 1 alerts us to another possible sell signal on 11/21/90, but like before, a quick check of module 2 fails to confirm the weakness. By 11/26/90, DEC is at $48 a share, module 1 is clearly flashing sell, but the ROC indicator in module 2 remains comfortably above its moving average. Still no change in our position. As we scroll forward from this point, we see that DEC finally begins to move higher, closing at a high of 59 1/4 on 12/18/90. Our sell signal occurs some two weeks later on 1/4/91 at 56 1/4.
Again, based on our established rules, we closeout our long position at 56 1/4 and we go short. As you will see in just a moment, this particular trade is a good example of the dreaded whip-saw we warned you against in a previous installment. On 1/16/91, before we are able to reverse our position, DEC pops to the upside, closing the session at 59 3/8. The result is a confirmed buy signal by modules 1 & 2. This prompts us to closeout our short trade and go long the stock at 59 3/8. We obviously would have been far better off simply riding out our original long position, established back on 10/22/90 at 51 3/4, but such is the nature of a whip-saw.
You will recall that in our last installment, our chart of DEC is updated through 1/16/91 and we have just initiated a LONG position at 59 3/8. Now let's slowly scroll forward one day at a time and watch the results of our trade unfold. Check each indicator module frequently for a possible closeout signal. Stop when you get to 2/15/91. Notice the TSV in 'module 1' has crossed decisively down through its moving average. Now let's check our indicator 'module 2' for confirmation. Module 2 fails to show similar action, having not violated its moving average. According to our rules, we must continue to hold our long position in DEC. Now, pull-up 'module 1' again and resume scrolling forward through time. A sell signal is finally rendered on 3/15/91 with DEC trading at 74 3/4. This is our cue to closeout our long position, which was originally established on 1/16/91 at 59 3/8 and open a new short position right here at 74 3/4.
In Friday's installment, we were working with a past chart of Digital Equipment (DEC). When we last left off, our ending chart date was 3/15/91. You will recall that we were long DEC from 1/16/91 (59 3/8) until 3/15/91 (74 3/4). Both modules 1 & 2 show that the indicators in each module are decisively crossing down through their respective moving averages. This renders a sell signal on 3/15/91, forcing us out of our long trade and into a short position.
Now let's slowly scroll forward on a daily chart and see how our short trade unfolds. The stock hits a low of 62 3/4 on 4/5/91 and then drifts essentially sideways for the next half-a-dozen sessions. On 4/17/91, module 1 has completed a positive crossover and module 2 has all but confirmed the buy signal. With the stock trading down some eights points (from our entry price) and with the indicator modules within a hair of issuing a signal, one might be inclined to exit the trade right here and take profits. But, for the purpose of our trading examples, our predetermined rules are not flexible, so we must stick with the position. The next day on 4/18, DEC pops sharply to the upside, closing at 70 3/8. As a result of the positive action in price, module 2 completes the positive crossover, thereby confirming a trade reversal. This means our short position established on 3/15/91 at 74 3/4 is closed out here (4/18/91) at 70 3/8 and a new long position is taken. Although this most recent short trade was profitable, we ended up giving back the bulk of our profits. We established the short position at 74 3/4 on 3/15/91. Approximately three weeks later, DEC was trading at about $63 a share. However, by the time we closed out our position on 4/18/91, DEC had already rallied back to 70 3/8. As you can see, knowing when to sell is even more difficult than knowing when to buy. What could we have done differently to better protect our profits? We could have implemented a simple strategy of a trailing loss-cut. In many instances, a trailing loss-cut can create a completely objective way of deciding when to take at least partial profits in a successful trade. We'll get more into loss-cuts at a later date.
Now let's get back to the trade at hand. You will recall, based on our simple rules of interpretation we are now long shares of DEC as of 4/18/91. So clip-back your daily chart of DEC to this date and let's begin. We're going to continue to work with the same two individual indicator modules 1 & 2. However, as you will see in a few minutes, this simple canned approach is less likely to produce the same favorable results in a trading range environment. Far more whip-saws tend to occur.
Start scrolling forward day by day using your right bracket key <]>. Check your indicator modules for the next reversal signal. On 6/10/91, with DEC trading at 66 3/8, our indicator modules signal us to closeout our long position and initiate a short position. This represents a loss of about six percent (excluding commissions) on our long trade. Remember, we went long DEC on 4/18/91 at 70 3/8. By 5/21/91, DEC had traded down to a low of 61 5/8. If we had employed a predetermined loss-cut when we first initiated the trade, we would have been stopped-out in early May with a five to ten percent loss. Instead, we were forced to hold our position until 6/10/91, while still incurring roughly the same percentage loss.
Religious followers of our indicator interpretation lessons are quite familiar with our short term trade scenarios using Digital Equipment (DEC) and our two indicator modules. We introduced these two indicator modules in our report dated, December 8, for the purpose of trying to deliver a totally objective means by which one could arrive at buy and sell signals. And since we did this as a kind of starting place for users interested in getting a better handle on what the technicals are saying, we felt we had to keep our approach as straight-forward and uncomplicated as possible. Please understand, we are not big believers in a purely automated approach to technical analysis, but since this approach is completely free of subjective interpretation, it is a logical starting point, a foundation if you will, for those wanting to develop and/or improve their indicator interpretation skills.
As we have said previously, these two indicator modules used in conjunction with one another are certainly not going to work effectively on all stocks in all situations, but they sure have worked remarkably well with DEC. For lack of a better word, this 'system' or purely objective approach, produced seven complete trades (opened and closed) from the period 3/12/90 through 6/10/91. Five of the seven trades were profitable, producing an average gain of 20.3%. Even more remarkable was the fact that the two losing trades were only down 5.6% and 5.7%, respectively. This means the average gain on all seven trades (losses included) was 12.9%.
It is our intention to continue working with DEC and these two indicator modules in order to see if this approach continues to work with the same effectiveness. This approach (as is the case with many technical trading methods) typically works better in a trending environment than it does in a trading range. However, based on our trade scenarios to this point, our whip-saws have been limited not only in number, but in the magnitude of losses as well. Most will agree that a couple of 6% losing trades due to whip-saws are certainly tolerable if it means being around to participate when that 44% move comes along.
Using both indicator modules and going back in time once again to the summer of 1991, we see that we are short Digital Equipment (DEC) as of the date 6/10/91 at a price of 66.38. Less than one month later, on 7/8/91, DEC pops to the upside, closing at 63.25, thereby triggering crossovers in both our indicator modules. This forces us to reverse our position from short to long. The short position netted us just over three points on the trade.
On 8/6/91, our first indicator module (daily chart with a TSV of 21 and a moving average of 10) completes a negative crossover. A check of the second module (2-day chart with an ROC of 18 and a moving average of 10) shows the indicator on the absolute verge of a negative crossover. However, since our rules are not the least bit flexible, "on the absolute verge" of a crossover is not a crossover. Of course, one day later on 8/7/91, both modules complete crossovers, signalling another reversal point. Our gain on the trade is a very nominal 2.68 points.
We are now short DEC as of 8/7/91, at a price of 65.88. On 8/29/91, our first indicator module shows a positive crossover, but our second module fails to confirm the signal. Some days later on 9/6/91 and again on 9/18/91, the first module completes positive crossovers, but in neither instance does the second module confirm the buy signal. DEC now stands at 55.25, more than ten full points below where we entered our short trade just five weeks before. As you scroll through this final week of September, you will see that DEC's price begins to stabilize and there are several points at which the TSV indicator module signals a buy. However, at no point does the second indicator module give us the necessary confirmation to reverse our short position. Finally on 10/4/91, both modules confirm a buy signal at 53.75. This prompts us to closeout our short position and open a new long position. The net result of our short trade is a 12 point profit or a gain of 18.4% over an eight week period.
You will recall, at the end of yesterday's segment, we initiated a long position in Digital Equipment (DEC) on 10/4/91 at 53.75. Now, let's scroll forward one day at a time and see how this latest trade plays out.
Following the buy signal, DEC rallies impressively to a high of $65 a share by the end of October. However, during the first days of November, DEC pulls back rather sharply from an overbought condition. On 11/5/91, with DEC now trading at 59, our first indicator module (daily chart with TSV) registers a negative crossover. But a quick check of our second indicator module fails to confirm, therefore we have no valid sell signal, as yet.
Scrolling ahead a few more days, we find that by 11/8/91, the short term correction in price appears to have run its course. Our first indicator module remains in a negative mode, but the second module still fails to confirm, keeping the current buy signal in force. By 11/14/91, DEC has rallied back up to a high of 64, but both modules still continue to contradict one another. Scrolling ahead now to 11/22/91, we continue to see much the same action. Price is in a consolidation mode; our first indicator module is in a sell mode; and our second module is in a buy mode. Remember, both indicator modules must be in agreement before we can reverse our current long position. On 11/29/91, with DEC trading at 63 and indicator module number one thoroughly entrenched in a bearish mode, indicator module number two is just a hair away from a confirming bearish crossover. The following day (12/2/91), DEC gaps down to 61.25 and as a result, we get our official sell signal. To review the trade, we went long DEC on 10/4/91 at 53.75. The stock hit a high of 65 on 10/31/91. And a sell signal was finally rendered on 12/2/91 at 61.25. This means we took about 7 1/2 points out of the stock in about two months time and we are now short DEC at a price of 61.25.
You will recall, in our last installment we initiated a short position in Digital Equipment (DEC) on 12/2/91 at a price of 61.25. Now, let's scroll forward on a daily chart using our first indicator module (TSV 21 with a MA 10) to help us detect a reversal point. Less than three weeks after the short signal, DEC hits a low of 48.5 on 12/20/91. However, scrolling ahead further we see that it is not until 12/30/91 that both modules reveal a positive crossover, thereby signalling a reversal of our position. Unfortunately, by this point DEC has traded back up to a price of 56.25, leaving us only a five point profit instead of twelve.
Obviously, this is a case where our entry worked much better than our exit, but the bottom line is we still made a profit on the trade. In fact, since we started running these trade scenarios on DEC using our two indicator modules (sometimes referred to as the Micro Timing Technique), our results have been quite remarkable. Nevertheless, in the coming weeks and months we plan to introduce a few new indicator modules that should help us to better identify a stock's underlying bias. Additional indicator module configurations used in conjunction with our Micro Timing Technique, may actually enhance the accuracy of our overall timing and ultimately translate into bigger profits on fewer trades.