Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Quantum AI Stocks Investing Priority - 26th Jan 22
Is Everyone Going To Be Right About This Stocks Bear Market?- 26th Jan 22
Stock Market Glass Half Empty or Half Full? - 26th Jan 22
Stock Market Quoted As Saying 'The Reports Of My Demise Are Greatly Exaggerated' - 26th Jan 22
The Synthetic Dividend Option To Generate Profits - 26th Jan 22
The Beginner's Guide to Credit Repair - 26th Jan 22
AI Tech Stocks State Going into the CRASH and Capitalising on the Metaverse - 25th Jan 22
Stock Market Relief Rally, Maybe? - 25th Jan 22
Why Gold’s Latest Rally Is Nothing to Get Excited About - 25th Jan 22
Gold Slides and Rebounds in 2022 - 25th Jan 22
Gold; a stellar picture - 25th Jan 22
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Stock Market Melting Up, A Different Take

Stock-Markets / Stock Markets 2010 Mar 31, 2010 - 06:38 PM GMT

By: Guy_Lerner

Stock-Markets

Best Financial Markets Analysis ArticleOver at the ZeroHedge website, they have a post attributed to Michael Panzer of the Financial Armageddon website entitled: "The Latest Red Flag - The Market's Rate of Melting Up". Here is a different take.

From the Panzer article, I quote: "Based on data going back 90 years, whenever the 12-month rate of change (ROC) in the Dow Jones Industrials Average has exceeded 40 percent, it has generally signaled trouble ahead."


I would disagree with that statement, and to understand why, let's put together a very simple study and replicate Panzer's observations. Like Panzer, our data set is the Dow Jones Industrial Average going back 90 years. I will also use the 12 month rate of change (ROC) indicator, and my strategy is to "buy" the DJIA when the indicator exceeds the 40 percent level. I will sell my position after holding it for exactly 12 months.

Now the purpose isn't to develop a trading strategy, but to show you what happens to the DJIA after the ROC indicator exceeds the 40% level, and the best way to demonstrate my "different take" is through the use of the maximum adverse excursion (MAE) graph. See figure 1.

Figure 1. MAE Graph

MAE assesses each trade from the strategy and determines how much a trade had to lose in percentage terms before being closed out for a winner or loser. You put on a trade and if you are like most traders, the position will move against you. MAE measures how much you have to angst and squirm while you are in that position. Because once you close the position out for a loss or a win, you are done worrying about it. As an example, look at the caret in figure 1 with the blue box around it. This one trade lost 16% (x-axis) before being closed out for a 8% winner (y-axis). We know this was a winning trade because it is a green caret.

So what does the MAE tell us about our strategy of buying the DJIA after the ROC indicator exceeds 40%? We had 12 trades since the 1920's. Two trades had excessive or portfolio ruining draw downs (or MAE's) and these were 1929 and 1987. 7 trades had MAE's less than 6%, and this would be the trades to the left of the blue vertical line. I would consider this a very tolerable draw down especially since 4 of those trades returned over 20% for the 12 month holding period. More importantly, 9 of the 12 trades were winners, and even a moderately excessive MAE of 16% recovered.

I think utilizing the MAE graph and methodology is a much better way to look at the data. Panzer states that on 11 occasions "rapid advances have been followed by notable corrections". This statement doesn't take in to account possible losses or draw downs experienced by the investor. For example, a 10% correction could have occurred after the DJIA had already run up 15% or so. In this instance, the investor would not have suffered a loss of principle despite the correction. Panzer's statement isn't as informative as the MAE graph, which actually shows how much an investor has to angst or squirm because he has lost his principle.

One other graph is worth introducing and this is the maximum favorable excursion graph (MFE). MFE measures how much a trade runs up before being closed out for a loss or a win. See figure 2 for the MFE graph for this strategy, and look at the caret with the blue box. This one trade ran up or had gains of 15% (x-axis) before being closed out for a 9% (y- axis) winner. So this trade gave back 6% before being closed out a winner, and we know this is a winner because of the green caret.

Figure 2. MFE Graph

So what does the MFE graph tell us about this strategy? 8 out of the 12 trades had MFE's of greater than 14%, so at some time over the next 12 months after exceeding a 40% 12 month gain the DJIA ran up some 14% or more from the entry point 75% of the time.

Now, let's focus in on the caret inside the red box. This is the trade from 1929. As it turns out, this trade actually made 31% before being closed out for a 19% loser after experiencing a 33% draw down or MAE. So let me set the record straight on the 1929 Armageddon trade: 1) the ROC indicator exceeded 40%; 2) the DJIA went on to make 31% over the next 9 months; 3) over the following 3 months, the DJIA lost 38%. So what Panzer has left out is the fact that the 1929 trade had a 30% plus run up that the market eventually gave back.

When considering the MFE and MAE graphs and what really happens after the DJIA makes 40% in a year, I would have to disagree with Panzer's assessment. When the ROC indicator exceeds 40%, it doesn't always signal trouble ahead. Even the 1929 trade actually had a 31% gain before being closed out for an 18% loss. If a trader or investor "gives back" that much, they probably should not be in the market in the first place.

I can easily make the argument that a 40% gain in over a year implies strong momentum that is likely to continue. But I won't make that argument, and instead, I will just state that this appears to be what it is: another data point that doesn't provide too much clarity.

By Guy Lerner

http://thetechnicaltakedotcom.blogspot.com/

Guy M. Lerner, MD is the founder of ARL Advisers, LLC and managing partner of ARL Investment Partners, L.P. Dr. Lerner utilizes a research driven approach to determine those factors which lead to sustainable moves in the markets. He has developed many proprietary tools and trading models in his quest to outperform. Over the past four years, Lerner has shared his innovative approach with the readers of RealMoney.com and TheStreet.com as a featured columnist. He has been a regular guest on the Money Man Radio Show, DEX-TV, routinely published in the some of the most widely-read financial publications and has been a marquee speaker at financial seminars around the world.

© 2010 Copyright Guy Lerner - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Guy Lerner Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in