THEORY
Is There Any Consistency In The Markets?
How Random Is The Dow?
by Tony Baker and William Arnold
This study looks at the market fluctuations of the DJIA to determine
if there is any consistency in the markets.
One of the best-known, universally reliable
characteristics of the financial markets is their tendency to fluctuate.
In times of optimism or pessimism, rising or falling interest rates, inflation
or deflation, these deviations from short- and long-term trendlines are
the center of attention. While the theory that these fluctuations are to
some extent random is now widely accepted, we recently undertook a statistical
study of 100 years of daily Dow Jones Industrial Average (DJIA) closing
prices, looking for consistent short-term tendencies to supplement mechanical
systems for trading index futures. Not surprisingly, the results have implications
for other trading vehicles as well.
Figure 1: Short-term fluctuations. A simple display of
prices deviating from the moving average.
The DJIA suits our overall purpose of developing information for index
trading, and a large number of available datapoints makes this series an
attractive and popular source of statistical data. After surveying several
time frames, we decided to focus on short-term deviations of the closing
price from a 10-day moving average (MA) to look for general consistency.
Although many traders may use longer time frames such as 50-day averages,
these tend to obscure the shorter-term moves we were studying. All we looked
at were the closing prices and the 10-day simple MA, and used percentages
to make comparisons simpler.
TERMINOLOGY
The chart displayed in Figure 1 of DJIA daily closes from December 3
to December 21, 2001, illustrates the terminology we will use in discussing
results. We looked at and tabulated the number of days the DJIA spent above
or below the MA, and at its maximum percentage deviation from the trendline
during each period.
The 100-year period included 27,380 trading days and 4,098 penetrations
of the 10-day MA (2,049 crosses in each direction). These magnitude and
duration values are displayed in Figure 2. Over this 100-year period, the
average maximum departure above the 10-day MA was +1.6% and the average
maximum deviation below was -1.6%, but the duration of the excursions was
substantially different, with the average time spent above the MA nearly
two trading days longer than the time spent below it. This reflects the
overall upward trend in the series.
The bar graph in Figure 3 displays a different breakdown of this simple
deviation data during different time periods. The short-term deviations
have been surprisingly consistent. If the underlying dynamics of markets
have changed over the long period examined, you can't recognize it from
this data. On a percentage basis, the average deviation of these moves
is roughly the same for 1901-10 (1.4% above, 1.6% below) as for 1991-2000
(1.5% above, 1.4% below). This implies that logical stop or profit levels
set on a percentage basis are valid, no matter what period is being surveyed.
...Continued in the May 2002 issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the May 2002 issue
of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2002, Technical Analysis, Inc.
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