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Relating to Advance-Decline Breadth Data
In a general sense know of no really firm parameters–certain observations can be made regarding the relationships behveen the movements of the daily and weekly advance-decline lines (internal market) and the various weighted market indices (external market). The Value Line Arithmetic Index, an unweighted index that includes all the issues in the Standard & Poor’s 500 Index plus 1,200 additional stocks, appears more correlated with the New York Stock Exchange-based advance-decline line than other market indices, such as the Dow Industrials and the Standard & Poor’s 500 Index.
The advance-decline line and the Value Line Arithmetic Index are both fine indicators of how the typical mutual fund is likely to perform, but the performance of neither is as closely correlated to the mutual fund universe as the performance of the broadly based New York Stock Exchange Index.
Pre-Bear Market Comparisons
It is interesting to compare the results of the 1971-2000 period to the 1971-2004 period, which includes the bear market of 2000-2002. Using the 90% (buy) and 80% (sell) parameters between 1971 and 2000 would have produced rates of return while invested of 34% and maximum drawdowns of only 8.6%, with 72% of trades profitable. Major drawdowns of the new high/new low timing models took place during 2001 and 2002.
The bear market certainly affected the historical performance of this and many other stock market timing indicators, which underlines the importance of employing long and diversified periods of stock market history in research and in any evaluation of stock market-timing techniques.
The New York Stock Exchange Advance-Decline Line
The Application of the New High/(New Highs + New Lows) Indicator to the Nasdaq Composite
The Application of the New High/(New Highs + New Lows) Indicator to the Nasdaq Composite
For whatever reason-and, no doubt, there might be many-timing models tend to produce better results when applied to theNasdaq Composite than when applied the New York Stock Exchange-related market indices, such as the Dow Industrials and the Standard &Poor’s 500 Index.
For one thing, over the years, the Nasdaq Composite has tended to be more trending (greater autocorrelation, the tendency of prices to move in the same direction as the price movement of the previous day) than indices such as the Standard & Poor’s 500, whose movements generally appear more random day by day Therefore, everytikg else being equal, there is likely to be better follow-through to buy and sell signals related to the Nasdaq Composite than to signals related to, for example, the Standard & Poor’s 500 Index.
For another thing, the Nasdaq Composite is generally more volatile (average higher absolute price movement over various periods) than the majority of New York Stock Exchange-based indices. As a rule, timing models tend to be more efficient when applied to volatile, trending vehicles than when applied to quieter, more randomly moving investment vehicles. Keep these observations in mind as we evaluate the application of the new highs/(new highs +new lows) timing model to the Nasdaq Composite. Also keep in mind that although we are tracking the Nasdaq Composite we are doing so via New York Stock Exchange-based new high/new low data.
Method of Interpretation
Buy signals can be said to take place when the ten-day moving average of the NH/(NH + NL) ratio first falls to below 25% (very oversold) and then rises by approximately ten units-say, from 13% to 23%-indicating that downside breadth momentum has begun to reverse.
Buy signals also can be said to take place when the ten-day moving average of the ratio falls to below 30% (oversold) and then rises upward through the 30% level. Finally, buy signals can be said to take place if the ratio rises from below 70% to above 70%. if a buy signal is not currently in place.
Sell signals can be said to take place when the ratio falls from above 70% to below 70%, or, if you prefer, from above 80% to below 80% somewhat safer exit, though sometimes premature.
These parameters are not recommended as stand alone timing models, but more as a part of your general arsenal of indicators that can be used as a group for market analysis and forecasting.
The following, however, represents a fine set of buy or hold parameters related to new high/new low data that stands well on its own. The combinations of parameters that appear to have provided the best risk/reward ratios over the years are highlighted in the tables that follow.
These are the basic operating rules:
Buy or commit to hold existing stock positions when the ten-day average of new highs on the NYSE divided by the total of new highs and new lows reaches 90%.
Hold for as long as the ten-day average of the ratio NH/(NH + NL) remains above your choice of 90%, 8570, 80%, 75% or 70%.
Sell when the ten-day average of NH/(NH + NL) falls below the sell parameters you are employing.