Letters To The Editor

May 2010 Letters To The Editor

The editors of S&C invite readers to submit their opinions and information on subjects relating to technical analysis and this magazine. This column is our means of communication with our readers. Is there something you would like to know more (or less) about? Tell us about it. Without a source of new ideas and subjects coming from our readers, this magazine would not exist.

Address your correspondence to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499, or E-mail to editor@traders.com. All letters become the property of Technical Analysis, Inc. Letter-writers must include their full name and address for verification. Letters may be edited for length or clarity. The opinions expressed in this column do not necessarily represent those of the magazine. —Editor

SAMPLE INDICATOR VALUES

Editor,
I have a request. Would it be possible to include a set of sample data and expected indicator values when you provide the code for indicators? Perhaps you could post it at your website for download.

I just read “Empirical Mode Decomposition” by John Ehlers in the March 2010 issue. It’s a great article, and it’s very helpful that he has included the programming code. I have coded it into my backtesting software, and the indicator looks similar to the example figures in the article. But if I had a set of expected values, it would help a lot to verify that my code is working as expected. Without it, the code could be generating close or totally incorrect values and I would never know. Bugs like this could come from anywhere, such as incorrect coding or more often a simple typo. It would not have to be a lot of values, perhaps 500–1,000 bars.
—David

Thank you for your feedback. We will keep your request in mind and encourage our authors to supply this if possible.
—Editor

SUSPECT TRENDS — VOLUME ON THE LOWS

Editor,
I read L.A. Little’s article in the February 2010 S&C with interest (“Suspect Trends”) and was curious whether the volume on the lows gave similar confirmations to volume on the highs. When a lower low is accompanied by higher volume, does that mean the downtrend is likely to continue and vice versa?
—Fred Goodman

L.A. Little replies:
Absolutely — it works both ways. I should have pointed that out.

SWING POINT IDENTIFICATION

Editor, I read “Suspect Trends” by L.A. Little in the February 2010 S&C. I was wondering how the author identifies/defines swing points.
—Bruce Trinkwon

L.A. Little replies:
Swing point identification actually includes two steps: potential and actualized. Every bar where the current bar is lower than the bar previous to it is a potential swing point low. Conversely, every bar that is higher than the bar previous to it is a potential swing point high.

Considering the swing point low first, if today’s low is higher than yesterday’s low, then yesterday’s bar continues to be a potential swing point low. If four consecutive bars occur without a lower low than the original potential swing point low (five bars previous), then the potential swing point low becomes an actualized swing point low. The exact opposite occurs for a swing point high.

4% RULE INDICATOR

Editor,
As a follower of the 4% rule indicator for many years, I would like to point out a problem with the article “The 4% Indicator” in the 2010 Bonus Issue of Stocks & Commodities. Ned Davis, who designed the 4% rule that was published by Martin Zweig in the book Winning On Wall Street, used the phrase any 4% change on a weekly closing basis to trigger a trade, rather than the week-over-week close mentioned by your article’s author.

The point of the 4% rule is to always be close to the trend, and that does not happen if one waits for a 4% week-over-week change before a new trade is issued.

Following the rules laid out by Zweig/Davis, a sell should be triggered on any 4% drop from any weekly closing peak, and a buy triggered on any 4% rise above any weekly closing trough.

The author in your article showed no trades in 2006, despite the Value Line index falling more than 12% in the spring of that year.

While there is nothing wrong with someone changing the rules of an indicator, I believe it is important for investors to know the dangers of those changes. If the stock market fell 3% each and every week, an investor caught long would eventually lose his entire portfolio value following the rules as laid down by the author of your article — as no week-over-week drop of 4% would land — whereas the Davis/Zweig version of the 4% rule would have the investor out, or short, once a weekly close was secured from the peak that would start such a great slide.

The Zweig/Davis 4% rule keeps the investor close to the trend, which ensures that losses remain small, while the system described by this article does not have such safeguards, and there is no telling how far a trend reversal can run before a 4% week-over-week change lands.
—Kevin Wilde

The author offers the following response:
First, the TT model as outlined in the article is my own version and my own application of the 4% indicator that Martin Zweig featured in his book,
Winning On Wall Street. It was not my intent to replicate his model as described in his book; however, I felt it important to recognize him as my source for the 4% indicator. I should have made this point clearer in the article.

In your letter, you paint a scenario that an investor using the TT model could lose his entire portfolio value if the market fell 3% for a number of consecutive weeks, as no exit signals from the TT model would be generated. In theory, this might be true, but actual backtesting results for the past 21 years do not support this claim. Further, is there not a scenario where the use of the “traditional” Zweig model could cause ruin? Since Zweig uses weekly closes in his model as outlined in the book, then in theory, an extremely volatile market could cause investors to get whipsawed for so many weeks and produce consecutive losses such that an investor could be wiped out as well. We will agree the chances are remote, but this could happen. Nonetheless, this has not stopped us from using his successful model.

In backtesting from 1989 through 2009, the TT model produced similar total returns as the traditional Zweig model return (actually slightly higher). In addition, both models experienced similar drawdowns but at different time periods. The TT model produced an approximate 35% loss from the period 4/4/94 to 5/5/97. On the other hand, the Zweig model, from 11/5/99 to 9/22/00, produced a 36% loss, experiencing 11 consecutive losses.

In any event, your point is well taken and I offer the following suggestion. Perhaps an investor should consider adding another rule to the TT model to address your concern: a 15% stop-loss. That is, if any signal goes against the investor by 15%, the trader automatically closes the position and waits for the next signal. Backtesting the TT model with this rule would have produced a total return of 258% and not the 420% published return, the difference being that the June 30, 2008, sell signal would have been stopped for a 15% loss. This would have reduced the drawdown but also negated the 23% profit if the trader had held. More important, this total return is still greater than the traditional Zweig model return of 163% produced during the same period and significantly greater than the index returns, supporting the relevance of this 4% indicator. Finally, if one compares the risk (as measured by standard deviation) associated with the TT model and the traditional Zweig model over this period, one will find a significant difference. The TT model shows a standard deviation of approximately 14 and the Zweig model shows almost twice the volatility with a standard deviation of over 28. It seems for the period 2001�09, the TT model produced greater returns while incurring significantly lower risk than the traditional Zweig model. Also, in this nine-year period, the TT model produced one losing year and the traditional Zweig model produced three.

You point out that the TT model showed no trades in 2006. This is correct, as no signals were generated. The TT model was long for the whole year, producing a 16.95% annual return. On the other hand, the traditional Zweig model experienced two trades and produced a total return of 19.47% for the same period.

The backtesting of the TT model attempts to verify the validity of a 4% weekly change. Does this 4% weekly change give the investor an edge in anticipating potential trend changes without large drawdowns? For the time period under review, the TT model numbers presented seem to suggest this.

As you point out, all trading systems have limitations and risks, including the TT model. Past performance is no guarantee of future results. Evaluating past performance, however, serves as a good starting point for future analysis. Perhaps I should have been clearer in the article addressing this issue. Nevertheless, whether you use the traditional Zweig model or the TT model, the 4% indicator remains a helpful tool for investors to identify trends. This was the point I was trying to make in the article.

Thank you again for your constructive comments.

DELTA VALUES AND NAKED STRANGLES

Editor,
Charles Steiner’s article, “Diary Of A Strangle” (Bonus Issue 2010), left me confused on how he balances the delta for a naked strangle. He states, “Delta-neutral refers to the strategy of balancing the positive deltas of the short calls against the negative deltas of the short puts…” As shown in the following table, short calls have a negative delta, and short puts have a positive delta.

Delta values used for the four basic legs and underlying asset:

            Leg
           Delta
            Leg
           Delta
       Long call (buy)
             +
          Long put
             -
      Short call (sell)
             -
          Short put
             +
Long underlying asset (buy)
             +1
Short underlying asset (sell)
             -1

Unless options on futures trade differently than equity options, it is unclear to me how Steiner achieves a delta-neutral spread. I noticed that the Traders’ Glossary in the Bonus Issue includes an expanded list of trading terms, but it does not include “delta.”

As always, I thoroughly enjoy the stimulating articles found in S&C.
Chris Pflum
Las Vegas, NV

Charles Steiner replies:
Your delta values are the correct position values. All of my values are reversed. They represent the Garman Kohlhagen model used for currencies, which takes into account the difference in interest rates between the two currencies. My position deltas are obtained from the calculator. The screenshots were not published but are shown in Figure 1. Sorry for the confusion, but the net result is the same when you balance the position deltas.

Image 1

FIGURE 1: position deltas

CUSTOM CODE

Editor, Code isn’t given in your magazine for the program I am using. Can you provide it?
—James

If code is provided in the magazine for a program other than the one you use, we suggest contacting the technical support department for the software you are using to request equivalent code. Of course, not all programs are customizable. Unfortunately, we are not able to provide custom code for every program.
—Editor

NOVICE TRADER’S NOTEBOOK

Editor, I am unable to connect to your site and would like a copy of your Novice Trader’s Notebook and any other information or articles you can provide to a novice retired trader.
—Al Frederick

Unfortunately, our Novice Trader’s Notebook isn’t available in hardcopy format. However, from time to time we publish articles geared toward novice traders in the monthly printed issues of Stocks & Commodities.
—Editor

ERRATA: 2010 READERS’ CHOICE AWARDS

Due to a typographical error, the heading “Favorite Articles 2008” should have read “Favorite Articles 2009” for that category of our Readers’ Choice Awards, which appeared in the 2010 Bonus Issue. This category of the Readers’ Choice Awards was a listing of articles that readers voted their favorites of the past year.

IN MEMORIAM: THOMAS MASKELL
Stocks & Commodities and Working Money contributor Thomas Maskell, 64, passed away on January 4, 2010. His well-received series on 10-bagger stocks capped the variety of articles on investment and finance that he wrote for Technical Analysis, Inc. A ceramic engineer before his retirement, he also developed multiple board games and received numerous patents for them. In 2008, Maskell fulfilled a lifelong goal with the release of his book, The Complete Guide To Investing During Retirement. In his own words, “I’ve had a good life and I could not have asked for anything more.” He will be missed.



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