CHARTING TECHNIQUES

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A Novel Approach To Market Timing
Combining A/D Indicators And Volume Patterns

by Victor Kalitowski and Andrew von Stuermer

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Here's a novel approach to market timing that can forecast mid-term runs on the S&P 500.

There are certain critical advance and decline levels that serve as excellent high-reward/low-risk entry points to go long the Standard & Poor's 500 for a mid-term run. We have found critical levels associated with two A/D ratios applied to the S&P 500. You can, however, use the indicators to trade any of the S&P 500 constituent stocks. We chose the S&P 500 mainly because many analysts and money managers consider it to be the best proxy for market sentiment. Our findings are based on an analysis of historical data dating back to June 1997.

ABOUT THE A/D INDICATORS

Advances and declines (AD) are well-known indicators used to gauge market strength or weakness, so armed with AD data, you can assess how strong a current trend really is. We use two specific ratios based on the advance/decline (A/D) concept:

• A/D issues
• A/D volume

The A/D issues ratio simply indicates whether a majority of stocks were traded at higher or lower prices relative to the close of the previous trading session. An A/D issues ratio with a large positive value indicates a strong market performance (positive market momentum), while a negative ratio represents a weak performance (negative market momentum).

Whereas the A/D issues ratio deals strictly with the number of issues that advance and decline, the A/D volume ratio goes one step further: It introduces the critical element of volume into the equation. Volume plays an essential part in A/D analysis because it is the best sentiment indicator. Volume also indicates the degree of market strength. Because it is the underlying cause of all price movement, volume data provides a true reflection of what is really happening in the market. After all, there can logically be no movement in a security if there is no change of volume.

  ...Continued in the December issue of Technical Analysis of STOCKS & COMMODITIES

Excerpted from an article originally published in the December 2005 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2005, Technical Analysis, Inc.