October 2008

The publication for trading and investment professionals www.technicalanalyst.co.uk

Global Sell Off

Technical levels give direction to markets

Interview Techniques Special Feature

Jason Perl of UBS talks Trading the futures markets Chris Charlton of
about DeMark indicators with Howe’s Limit Rule Centa AM discusses
currency asset management
7HEN THE MARKETS MOVING FAST YOUR TRADING SYSTEMS NEED TO MOVE FASTER 4HATS WHY
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 WELCOME
Just when you thought things couldn’t get any worseHwith sentiment being so
negative at the moment for all markets, not just stocks, it is perhaps time to take a
contrary view, as advocated by Anthony Bolton. Technical analysis has much to
offer in this area and the indicators of Tom DeMark work specifically as a coun-
tertrend signal generator for both the short and long term. In this issue we summa-
rize DeMark’s recent talk in London, review a new book on his indicators, and look
at the D-Wave, a DeMark take on Elliott Wave formations.

We hope you enjoy this issue of the magazine

Matthew Clements, Editor

CONTENTS 1 > FEATURES OCTOBER

US stocks: 1973/74 revisited
We summarise Tom DeMark’s recent talk at
Bloomberg’s offices in London and the views he
gave on the markets
>08

2008: presidential election

cycle update >18
Dimitri Speck of Seasonal Charts looks again at
the cycle and how stock markets may move as
the election day approaches

Interview
We speak to Jason Perl, head of technical
analysis at UBS about how he uses DeMark
indicators in his client research
> 41

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cannot accept liability for any errors or omissions that may appear or loss suffered directly or indirectly by any
reader as a result of any advertisement, editorial, photographs or other material published in The Technical
Analyst. No statement in this publication is to be considered as a recommendation or solicitation to buy or sell
securities or to provide investment, tax or legal advice. Readers should be aware that this publication is not
intended to replace the need to obtain professional advice in relation to any topic discussed.
>>
October 2008 THE TECHNICAL ANALYST 1
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CONTENTS 2 > REGULARS

MARKET VIEWS
Editor: Matthew Clements FTSE 100: major low at 3277 04
Managing Editor: Jim Biss
Consultant Editor: Trevor Neil AUS/USD: outlook to the downside 06
Advertising & subscriptions: US stocks: 1973/74 revisited 08
Louiza Charalambous
Marketing: Vanessa Green
Events: Adam Coole
Design & Production: SPECIAL FEATURE
Stuart Field Currency Asset Management 10

The Technical Analyst is published by

TECHNIQUES
Howe’s Limit Rule 16
2008: Presidential Election Cycle Update 18
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Observations on Lunar Phase & US Panics 22
1-5 Jeffries Passage Stumbling on Value Investing 25
Guildford Volatility Trading using the VIX 28
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INTERVIEW
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October 2008 THE TECHNICAL ANALYST 3

 Market Views

FTSE 100:
major low
at 3277
By Sandy Jadeja

Sandy Jadeja
4 THE TECHNICAL ANALYST October 2008

The financial markets have been hit by a tornado of selling which has taken
major indices to new five year lows. The question on investors and traders
minds is how bad can this really get?
Support levels
The UK FTSE 100 index has already lost 37% from the July
2007 high of 6754. A bear market is considered if a decline
of 20% or more is in place. Clearly we have surpassed this
and sentiment figures are showing that we are already in a
bear market. One should remember that the rally we saw
from March 2003 reached a high of +106% and so the
decline can be counted as a retracement, albeit a major one.
Unless we surpass 3277 on the FTSE - which equates to the
neckline of a double top formation (see Figure 1) - the cur-
rent move is still classified as a correction.
Figure 1
Technically the key support levels are 4605 and 4020 of
which the latter should hold the index up. If we fail to stay
above 4020 this would have serious implications for the
index as the next support level would be below the major low
coming in at 3277. Although this sounds unrealistic we
should remember that when oil had been trading at $37 dur-
ing 2003, expecting the commodity to reach a gain of more
than 400% also seemed unrealistic. In the current environ-
ment anything is possible.
Historically we know that the months of September and
October are disastrous for the stock market and this year is
no different. If we are to see a late rally then a break above
5090 is required to turn the downward trend to an upward
trend, at least in the short term for the FTSE 100.
Buying opportunity?
Some analysts feel that the market is cheap and ripe for the
investor to get in and pick up bargains. History has taught us
that trying to catch a falling knife is dangerous and should
not be attempted. My view is that a significant reversal is
required where we see at least a higher close on a weekly price
October 2008
Market Views
bar before attempting to buy a particular stock. Many have
tried to capture bargains in the financial stocks only to have
found that the pain of losing can be excruciating as it has
been in this particular sector.
If we take seasonality and cycles into consideration, the
year 2007 was already flagged as being a potential high. We
know that years ending with sevens tend to be marked by
market highs and years ending with twos offer market lows.
This suggests that we are likely to be in a bear market until
2012, with a strong corrective rally during 2009. The major
indices had also reach Fibonacci Price Extensions and Elliott
Wave traders had seen a major five wave pattern pointing to
a market fall.
Turning points
In the current market if one were to use oscillators and lag-
ging indicators, such as moving averages, one would find that
these tools would be rendered useless. The market has tech-
nically been oversold for three months now and oscillators
tend to perform poorly in trending markets. For short term
forecasts a break above the weekly high is far more superior
for the bulls and vice versa for the bears. Price tools have
always been more powerful than indicators which are simply
derivatives of price anyway.
Analysing open interest figures has shown that there have
clearly been more sellers than buyers recently and volume on
the downside has been three times greater than the upside on
average. This is typical in downtrends once panic kicks in. We
still do not have a full out bearish sentiment at the extreme
which is required to see a major reversal. Time analysis points
to October 14-17 or the last week of October as potential
turning points. We also have mid November as an extreme
cycle date. Combining timing with classical technical analysis
should prove useful for technical traders.
Once we have a firm low in place this would have complet-
ed a “phase one” which should be followed by “phase two”
a corrective rally. This should take us into 2009 and then the
technical picture shows that another leg down could take
place as the “phase three” which could be very devastating.
Analysts such as Bob Prechter and Albert Edwards also have
come up with similar conclusions that the decline is not yet
over. It is possible that we could still see a further 20%
shaved off current levels in the next phase.
Sandy Jadeja is chief market strategist at ODL Markets
THE TECHNICAL ANALYST 5
 Market Views
AUS/USD:
OUTLOOK TO THE DOWNSIDE
By Mohammed Isah
Reversal ahead of the 0.8005/0.7991 zone to herald recovery
AUD/USD came in strongly off its recent low at 0.7802 to
close higher at 0.8362 recently. This is coming on the back of a
collapse off its YTD high at 0.9851 in mid-July’08 (Figure 1).
Source: ProRealTime
Figure 1: Weekly Chart
Before the pair’s recent sell off, AUD/USD had enjoyed an
uptrend dating back to Sep 2001 after a bearish trend struc-
ture that began in Dec 1996 and bottomed at 0.4825/51 in
April/Sep 2001. While pullbacks off its Feb 2004 high at
0.8005 were seen, and subsequent retests failed at the 0.7773
level in Nov 2004 and the 0.7872 level in Mar 2005, price
consolidation that ensued developed into an ascending trian-
6 THE TECHNICAL ANALYST October 2008
gle (a continuation chart pattern) which ultimately broke out
to the upside in Mar 2007.
Target of 0.9230 reached
Having decisively resolved to the upside, two technical issues
were triggered: the first being the resumption of its longer
term uptrend started in Sep 2001, and the second relating to
meeting its ascending triangle pattern price target at 0.9230
established by measuring the width of the pattern and pro-
jecting it from the breakout point. Although setbacks
through the breakout point and the 0.8005 level occurred in
Aug 2007 after the pair attained a high of 0.8873 in July 2007
(Figure 2), recoveries off the 0.7676 low (Aug 17 2007 low)
saw the pair resume its long term uptrend and later achieve
its breakout target at 0.9230. With the pattern of higher highs
and higher lows established, AUD/USD rallied to a high of
0.9851 in mid-July 2008 after a two-month corrective pull-
back was seen in Nov/Dec2007.
Overbought signals
With clear overbought signals displayed on both the weekly
and monthly charts (though parity status was looming fol-
lowing AUDUSD’s attainment of its highest price since
1983), the collapse off the mentioned high was technically
expected though the sell off was fast and deeper than envis-
aged.
Although the parabolic declines tested the 0.8005/0.7802
levels and turned back above there while key supports at the
0.9328 (June 2008 low), 0.8954 (Mar 2008 low) and 0.8512
(Jan 2008 low) levels remain unbroken, the medium term
outlook continues to point lower implying its bounce off the
0.8005/0.7802 area is corrective of its weakness started at
0.9851. Our medium term target resides at the 0.7676 level,
its Aug 2007 low and its 100 monthly EMA at 0.7570.
On the other hand, as indicated above, a combination of
oversold conditions, parabolic declines, the formation of →
 Market Views

two hammers, and the provision of support by the

0.8005/0.7991 zone have triggered the present recovery
higher. This corrective recovery based on its foundation
should target the 0.8512 level on a follow-through to the
upside from the mentioned hammers with possible further
strength to the 0.8954 level.
On the whole, as long as the losses of the earlier men-
tioned key support levels and bearish monthly and quarterly
studies remain in place, AUDUSD’s broader (medium term)
outlook remains to the downside.

Mohammed Isah is a Technical

Strategist and Head of Research at
FXTechstrategy.com, a technical
research website. He was also a for-
mer market analyst and head of
research at Fxinstructor LLC.
FXTechstrategy.com offers to its
client’s daily and weekly technical
commentaries on currencies and com-
modities. Mohammed can be reached
Figure 2: Monthly Chart Source: ProRealTime
at m.isah@fxtechstrategy.com.

October 2008 THE TECHNICAL ANALYST 7

 Market Views

Tom DeMark
8 THE TECHNICAL ANALYST October 2008
 Market Views

US STOCKS:
1973/74 REVISITED

A summary of Tom DeMark’s recent talk in London and his views on the markets

Monday October 6th saw Tom DeMark give another of his
annual talks at the London offices of Bloomberg, part of a
whistle stop tour of the major European financial centres.
These have proved to be very popular in the past but dramat-
ic events in the markets on the day threatened to dampen
turnout. In the end, DeMark need not have worried: atten-
dance was impressive with close to 200 hearing him give his
views on the markets and discuss his indicators.
all-time high of 6700.
However, DeMark is not a charting purist. His rational for
the fall in US stocks next year is based on political-economic
factors: namely, Barack Obama winning presidential election
this year. Once he takes office in the White House next year,
his administration will be perceived as being anti business and
pro higher taxation.

1973 and today

His talk centred on the similarity between the markets in
1973/74 and today. By overlaying charts from the two peri-
“THE LOW OF W/C 6TH
ods on top of each other, DeMark dramatically highlighted OCTOBER WILL SEE THE START
the similarity in price patterns and volatility levels over one
year periods for US stocks and oil. Prices today are likely to OF A RALLY TO THE END OF THE
go on to continue this correlation next year. This view was
also supported by a wide range of technical factors using his
YEAR, BUT THE FTSE 100 WILL
own indicators and Fibonacci retracements. In the short to THEN RESUME ITS DECLINE TO
medium term a stock market rebound will present a good
buying opportunity. After that, the outlook becomes much A LOW OF 4150 BETWEEN
darker.
MARCH AND OCTOBER 2009”.
DeMark indicators
Using the TD Sequential, DeMark showed that the S&P500 TOM DEMARK
is at a Countdown “13” – a key indicator of market exhaus-
tion and a potential major price turn. This is also supported
by his measure of market volatility, or fear gauge, the VXO.
This has proved to be a reliable indicator for market lows Fibonacci
whenever it has spiked about the 50 level. This was the case DeMark also highlighted his faith in Fibonacci retracements.
in 2001 after September 11 and is happening again this Indeed, many of the parameters he uses in his indicators are
month. Furthermore, this is typically followed by a rally of based on the Fibonacci sequence. He drew particular atten-
20% or so before further unravelling takes place. As such, the tion to levels to be expected from a market top based on the
low of w/c 6th October will see the start of a rally to the end classic 61.8% retracement. For example, oil = $90 (from $144
of the year, but the FTSE 100 will then resume its decline to x 61.8% - this retracement is also what happened in 1973/4).
a low of 4150 between March and October 2009. This target From this retracement, DeMark sees a price target for the
is based on a 61.8% Fibonacci retracement from the market S&P500 of 960 between March and October next year.

October 2008 THE TECHNICAL ANALYST 9

 Special Feature

10 THE TECHNICAL ANALYST October 2008

 Special Feature

CURRENCY ASSET
MANAGEMENT
We talk to Chris Charlton of Centa Asset Management about his multi-manager investment approach to
the foreign exchange markets

Chris Charlton has been actively involved in the inter-

national foreign exchange markets for over 30 years,
starting his career at J.Henry Schroder Wagg in 1974.
At Merrill Lynch in the eighties he ran the London-
based trading desk for large institutional investors, and
later at Security Pacific bank he was responsible for
advising European central banks. In the mid-nineties he
ran the treasury sales desk at Credit Lyonnais/BfG Bank
in Frankfurt, and his last post in FX was as treasurer of
Bankhaus Wölburn, a private bank in Hamburg. He has
been running his own business since 2002 focusing on
currency asset management and consultancy services.

October 2008 THE TECHNICAL ANALYST 11

 6-8 November 2008
Le Meridien Etoile
Paris, France

Conference Includes
Thursday 6 November Friday 7 November Saturday 8 November

Walkabout, traditional IFTA round Prof. Carol Osler (Brandeis University): Tony Plummer: the logic of non-
tables meeting analysis of stop-loss or
orders
ders rational behaviour in financial
Chistopher Neely (Fed de St Louis): distribution and its rrelation
elation to market markets
rrelationship
elationship between or
order
der flow and volatility Claude Mattern (BNP): strstrength
ength and
macroeconomic
macr oeconomic announcements on Y
Yasmina
asmina Hasanhodzic (MIT): limit of technical analysis : market
the for
forex
ex market demystifying and automating action, interpr
interpretation
etation and price
technical analysis and hedge-fund anticipation
2009 outlook by a panel of strategists
strategies Private visit of the museum and gala
Dinner cruise on the Seine Y
Yannick
annick Daniel (Société Générale): dinner at the Louvre
combining behavioural financial with
fundamental inputs in a hedge fund
Maxime V Viémont
iémont (BNP): hybrid trtrend-
end-
following strategies

Full pr
program
ogram on www
www.iftaparis2008.com
.iftaparis2008.com

Registration and accomodation by phone +33 1 53 85 82 82

and on: www.iftaparis2008.com

Delegate fee: 900 € + VAT (IFTA member)

Delegate fee: 1200 € + VAT (non-IFTA member)

TA: What is the difference between a FX multi-manager
and fund of funds approach?
CC: From the concept of modern portfolio theory, very lit-
tle. Both look to reduce risk by diversification. The difference
lies in the scope of investment opportunities and the struc-
ture of the investment vehicle. There are a vast number of
currency managers available (CTAs) to choose from whilst
the number of currency funds is limited. As the name
implies, fund of fund managers can only invest in funds and
therefore the investment choice is limited.
The difference in structure is more complex but there are
a few important points. In many cases a fund of funds will
not be able to know its real exposure and results until all the
different funds have reported their own. Liquidity can be a
problem and there can be restrictions on entry and exit. In
our case - the multi-manager route - we have daily liquidity so
we can exit or change the portfolio on a daily basis as well as
our investors. We have daily reporting so we know exactly
what each of our managers is doing and we can see our total
currency exposure. Another point is that a fund of funds may
charge extra fees in that they often charge an extra manage-
ment and performance fee on top of the individual fund fees.
This can add up. At Centa, we do not charge any perform-
ance fee.
TA: What are the advantages of investing in a multi-
manager fund rather than a single manager one?
CC: This is classic portfolio theory; diversification reduces
specific risk. By investing in a number of managers with dif-
ferent strategies, one can reduce the risk of the overall port-
folio down to a certain point whilst still expecting to achieve
a satisfactory return.
TA: Whose money do you manage and how much do
you have under management?
CC: We have designed the product to be eligible for both
institutional and retail investors. There are different ways of
reporting AUM. We launched the product in January and at
the present time we have $64 million under management.
TA: Can you explain the process you go through in
selecting your managers?
CC: We select our managers via the Deutsche Bank platform
called FXSelect platform and it is a perfect solution for an
investor who wishes to invest in a single manager or an index
of his choice. One example is that the investor has a single
contract with Deutsche bank rather than having individual
ones with each manager.
We have decided that around ten managers is a suitable
number for our programme. We have a universe of about 100
October 2008
Special Feature
managers that we look at and search for ones that meet our
criteria. We start using basis quantitative analysis and
progress through various stages of more complex due-dili-
gence until we come out with a core number of managers
that suit our expectations.
To begin with we look at some traditional statistical analy-
sis such as absolute returns, maximum drawdown, Sharpe
and Sortino ratios. We then look at the managers’ trading
strategies and conduct look-back analysis to check their
robustness. An important part of this is the comparison
analysis with our own in-house benchmark portfolios. We
also put great emphasis on qualitative analysis and this is the
next step: we look at factors such as staff turnover, risk con-
trols and back up, administration, office location and others.
Once we have arrived at a core number of managers we
then conduct personal visits. It is our intention to get under
the skin of the managers and really understand their plans
and targets, their fears and anxieties, their daily routines and
pressures etc. We are specialists in behavioural analysis and
this plays a large part in our due-diligence.
Finally we come up with a simple question, Can we trust
these guys with our money going forward?
As I have said, for the programme we have come to the
conclusion that around ten managers is the optimal number
to provide a variety of trading strategies that will perform in
most market conditions and provide us with steady growth
within an acceptable risk profile.
TA: What’s different about your selection process com-
pared with other multi managers?
CC: We put a lot of emphasis on the behavioural aspect of
managers not just the traditional statistical returns. We have
five members in our asset allocation committee all with over
thirty year’s individual experience in the markets. I believe
that combined we are in a better position to judge managers
and their strategies. That is our advantage.
TA: How do you decide on the weightings that you give
each manager? Is it purely performance related?
CC: Preferably we like to have a relatively even distribution
but there are cases where we will have lower or higher weight-
ings. If a manager has a high volatility then we will be biased
to have a lower weighting despite the potentially higher
returns and vice-versa. In other words we are always looking
at ways of reducing risk and volatility rather than just produc-
ing high returns.
We will also look at the strategies: many managers will be
active in all markets which means we have to look at their
individual exposures to certain currencies. We have our over-
all limits to different currencies within the total portfolio and
this will then affect the weightings of the individual man-
agers. →
THE TECHNICAL ANALYST 13
 Special Feature
TA: Why do you think there are so few fund of fund cur-
rency managers?
CC: This is because it is only relatively recently that curren-
cies became a recognised asset class and therefore there are
only a limited number of currency funds. I think you have to
differentiate between currency funds and currency managers
(CTA programmes) of which there are many. We have creat-
ed a multi-manager programme that can be integrated into a
fund or another structured product.
TA: What returns has the multi-manager programme
seen in the past 12 months. What is the Sharpe ratio?
CC: We launched the programme in the middle of January
this year and we are currently up 4.8%. I would like to stress
that the aim of our programme is to produce an annual
return of 5% over Libor. We are not expecting to see 20%
returns, and more importantly, we do not expect to see 20%
drawdowns. Looking back to 2004, the present portfolio has
a Sharpe ratio of 1.6 and has not had a monthly drawdown
exceeding 2%.
TA: What performance measures do you use to assess a
manager?
CC: For performance we look at traditional quantitative
measures such as Sharpe and Sortino ratios, drawdowns and
volatility. We also use a series of sentiment strategy bench-
marks to assess the success of manager strategies on a
monthly basis. For example these can be based on yield, trend
or volatility.
TA: You mention on your site that you look at the strat-
egy of a manager and assess if this is likely to continue
into the future. How do you assess whether a strategy is
likely to perform well in the future?
CC: If a manager has had a good year of returns it is not the
case at all that this will necessarily continue. A pure trend fol-
lower will under-perform in a consolidation market and vice-
versa. The carry-trade was a simple bet in 2006 and the first
half of 2007. Now it is far more complex. The main point
here is to look at the adaptability of the manager and how
much experience he has had in the market. Managers mostly
can be put into two classes: fundamental or systematic. Either
way we like to see that the managers are dynamic in their
approach to different market conditions. This is very impor-
tant.
TA: Can you give us some examples of the type of
strategies employed by the managers?
CC: Firstly we can differentiate between what currencies they
are trading. Let’s categorise them into G10 and Emerging
14 THE TECHNICAL ANALYST October 2008
Markets. Then we can look at their strategies: fundamental or
systematic, short-term or long-term. Many managers build
complex models to assess yield differentials, economic funda-
mentals and so-on. Many use technical analysis. As you can
see there are many variations.
TA: How do you assess the risk associated with each
strategy?
CC: This is an important point and we look closely at the risk
profile of each strategy. Most managers sets the risk level of
their strategies by allocating a risk budget and setting stop
losses to ensure that the budget is not exceeded. Thus the risk
is not simply associated with a particular strategy, but also
with its implementation.
TA: Are you looking for strategies that are uncorrelated
with other asset classes, strategies and FX rates?
CC: Generally we can say that currency returns are uncorre-
lated to the returns of other traditional asset classes such as
equities and bonds, but there are many situations where the
strategies may be correlated. An obvious example is the cor-
relation between the yen-carry trade and the equity market
performance, at least until recently.
We are not concerned whether the strategy is correlated to
other markets or not, rather that the strategy itself is robust,
has adequate risk parameters, and that we can feel confident
that we are protected should events change rapidly and the
correlation unravels.
TA: What strategies tend to perform best in periods of
high volatility and/or market turmoil?
CC: Short-term strategies tend to perform better in these
environments. The reason simply is that they have much
shorter profit and loss horizons. Although one can argue that
they could produce a series of small losses, the danger of
large losses is reduced. This is typical of models that have
more medium-term horizons and do not react quickly
enough to sharp moves in price or volatility. Therefore our
portfolio contains some short-term trading managers.
TA: What strategies and currencies have performed best
over the past 5 years or so?
CC: Certainly the carry-trade was the best performer, so long
high-yielders and short the yen and CHF. In the last two years
the US dollar gained prominence as a carry-trade currency as
US rates fell. This is being reversed now. It seems that the
markets are not so straightforward anymore and the best
example of this is when one looks at many managers who
have “hockey-stick” performance records. In that I mean
many years of positive growth and then a sideways move-
ment over the last few years.
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Howe’s Limit
Techniques

Indicator Focus:

Rule
Howe’s Limit Rule isn’t an indicator as such; it is more
of a trading strategy. Nevertheless, the “rule” does
provide trading signals of a kind that can be used in
futures markets where there are limits on permissible
daily price ranges.

Definition For instance, if a market trades at a "limit up" price then:

Robert Howe, a market technician and analyst, first offered
his rule in 1977. Howe's Limit Rule simply suggests that:
A price at the limit of a tradable daily range, once reached, becomes
an objective which the market will again test and ultimately exceed,
at least briefly and usually sooner rather than later.
Why should this be so? A primary function of any market
is to explore and discover value. A market that is artificially
interrupted (when limit up) in its pursuit of current value is
unsatisfied and leaves unanswered questions, such as how far
and how urgently the market would continue searching.
Unlike objectives derived from chart formations and mathe-
matical formulae which might approximate a target range,
HLR identifies precise price targets.
• Short-term traders may more confidently buy into any
pullback (whether intraday or during subsequent trading
days)
• Traders already long may be encouraged to maintain their
positions
• Prospective short-sellers may be discouraged from taking
immediate action and wait until the price level is exceeded
Trading strategy
By acting on the principles of HLR, each of the above would
expect any price decline to be small, unless and until the limit
price is exceeded by at least one tick. However, if after a pro-
longed trend a limit price is exceeded only briefly and tenta-
tively, a failure leading to a reversal may be imminent as
the market exhibits exhaustion. →

16 THE TECHNICAL ANALYST October 2008


“A PRICE AT THE LIMIT OF A TRADABLE DAILY RANGE, ONCE
REACHED, BECOMES AN OBJECTIVE WHICH THE MARKET WILL
AGAIN TEST AND ULTIMATELY EXCEED, AT LEAST BRIEFLY AND
USUALLY SOONER RATHER THAN LATER.”
As a corollary, an unexpected limit move in the opposite
direction of the prevailing trend can be an early warning of a
trend reversal (as everyone changes their minds at the same
time). Finally, an abrupt limit move out of a accumulative or
distributive congestion phase can signal the beginning of a
powerful new trend (as everyone tries to go through the same
door at the same time).
On the rare occasion when a lead contract leaves a traded
limit price "hanging" (not exceeded prior to its expiration),
that limit price is carried over as a future objective for subse-
quent lead contracts. As such, it can become a magnet for
intermediate- or long-term trend exhaustion. In other words,
the prevailing trend may be maintained and/or a new trend
suppressed from beginning until that "hanging" limit is
exceeded, often creating a double top or double bottom.
This happens because the lead contract is most cash-con-
nected and used on weekly/monthly charts. Hanging limits
October 2008
Techniques
on nearby contracts often become significant sup-
port/resistance points on weekly/monthly charts. Limits left
hanging in deferred contracts are specific to them only and
usually become irrelevant at expiration.
Exceeding the limit
According to the Moore Research Centre (MRCI), of key his-
torical significance are the first and third days immediately
following a trade at a limit price. In a majority of those mar-
kets a limit traded price has been exceeded on the first day
following 50-70% of the time. In almost all markets studied,
the analysis suggests the historical probability of exceeding a
limit price is often greater than 80% within 3 trading days,
and 90% within 7 trading days.
Many thanks to the Moore Research Centre (MRCI) and Jim Wyckoff
in the writing of this article.
THE TECHNICAL ANALYST 17
 Techniques

18 THE TECHNICAL ANALYST October 2008

2008:
Techniques

Presidential Election Cycle Update

By Dimitri Speck

Dimitri Speck of Seasonal Charts looks again at the cycle and how stock
markets may move as the election day approaches

Past performance may include measures financed through The vertical scale displays perform-
The direction of equity market prices is deficit spending and the (not complete- ance on a percentage basis. So in the
not really dependent on whether a ly independent) Fed supporting each first section of the chart above
Republican or a Democrat president is incumbent president through its mone- “Election” you see the average per-
elected. Recent presidential periods tary policies. But after the election formance of all election years, above
have shown solid equity markets under unpopular measures are piled on such “Post-Elect.” the performance of all
both Clinton (Democrat) and Regan as those designed to counter a sprawl- post election years is shown, above
(Republican). Thus the election cycle ing federal deficit. Figure 1 shows a typ- “Midterm” the performance during the
does not differentiate between political ical four-year election cycle going back middle part of the cycle, and above
parties but rather according to the year to 1897. “Pre-Election” the performance of →
of the presidency. During the last hun-
dred years or so the Dow rose on aver-
age 7.3% during a presidential election
year. In pre-election years it performed
on average an even better 9.3%. In con-
trast, in post-election years perform-
ance was only 3.4%, and in the subse-
quent mid-term years it was just 3.2%
on average. A comparable link between
equity market performance and the year
of the presidential election cycle already
existed during the 1800s. So, for a mar-
ket gauge it is a statistically well ground-
ed relationship.

Reasons for the cycle

Why are the years after an election weak
and the two years prior to an election so
good for equity markets? The reasons
are obvious: Presidents want to be re-
elected (or want a successor from their
own party) and so work to stimulate the
economy prior to an election in an
Figure 1.
effort to get voters on their side. This

October 2008 THE TECHNICAL ANALYST 19

 Techniques

future - although its fundamental caus-

es should remain relatively stable. This
assumption is supported by the obser-
vation that the economic cycle seems
to be subject to a four year pattern
(Figure 3).

Forecasting with the cycle

Figure 2.
all those years directly preceding an
election year. Average performance
during the entire four-year cycle
amounted to 25% on average.
The horizontal scale shows each year
of the four-year cycle. As previously
mentioned, election years (on the left)
and pre-election years (on the right)
have been good years for the stock mar-
ket. Both of the middle sections of the
chart, i.e. the post election year and the
midterm year hardly provided investors
with any profits. Let's now take a closer
look at the cycle’s current year, the elec-
tion year.
point is that many different values go in
to making up an average. Accordingly
there have also been exceptions during
election years. For instance, of the last
seven election years, two - 1984 and
2000 - ended in losses. So, one should
never expect the same results with
every election year. In addition, the
election cycle itself could change in the
The four-year election cycle can serve
as one of many decision-support tools.
What it ultimately does is increase the
probability of a price move. A cyclical
pattern is namely one among several
influential factors on price direction
such as sentiment, the dollar, oil, earn-
ings and the like. Thus it is feasible to
integrate the cycle into a widely-struc-
tured forecasting model as one of a
number of decision-making factors.
This is suitable for discretionary trading
decisions as well as for systematic trad-
ing approaches. In the process all input
factors are weighted and taken together
as a total.
Anyone basing trading decisions on
monetary policy, crude oil prices, the
currency situation and stock market
trends can also use the election cycle as
an additional decision factor.
Unfortunately one cannot know
beforehand which weighting an individ-
ual factor will have. In addition →

Election year
Figure 2 shows the average perform-
ance during election years only. The
weakness during the first half of the
year is clearly visible. Then the Dow
rises during the second half of the year
in typical fashion with a high in
November with Election Day. So dur-
ing election years, stocks move exactly
opposite to their typical annual season-
al pattern when they usually increase
during the first half of the year and per-
form modestly during the second half.
For example, an average price move
of 0% can be made up of a 10% price
increase and a 10% price decline. The Figure 3.

20 THE TECHNICAL ANALYST October 2008

 Techniques

“DURING ELECTION YEARS, STOCKS MOVE

OPPOSITE TO THEIR TYPICAL PATTERN WHEN
THEY INCREASE DURING THE FIRST HALF OF
THE YEAR AND PERFORM MODESTLY DURING
THE SECOND HALF.”

there are factors such as the current

credit crises whose influence on prices
can hardly be quantified in advance.

Other market cycles

It must be stressed that the election
cycle does not end with the election
year. It also influences the subsequent
three years, although the media pays less
attention to it. Next to the US stock
market, the currency and bond markets
also possess four-year cycles. Especially
noticeable in the bond market is the fact
that the year prior to an election is typ-
ically quite weak. It is exactly reciprocal
to the stock market, strengthening the
assumption that the two markets are
cyclically connected to each other
through investment preferences and
reallocation measures. Equity markets
in other countries also demonstrate a
four-year cycle. This results from the
dominance of the US markets whose
developments influence markets in
other countries. Incidentally, that even
goes for countries that have their own
election cycle running counter to the
four-year cycle.
Before and after Election Day
Next to the election cycle there is still
another, hardly noticed phenomenon
related to the election. The movement
of the US equity market directly before
the election. In order to study it more
closely, we’ve constructed a special
chart (Figure 4). It shows the Dow’s
average price during the weeks directly
before and after Election Day. This
occurs during a period of six months –
three months prior to the election and
Figure 4.
three months following the election. impulse is expected from the new team
Thus the day of the election is used as in the White House. This optimism,
an anchor for the study as opposed to even if it is caused by something unre-
the calendar. Indeed, the election does lated, stimulates the tendency to buy.
not always take place on the same day of
the year. In this way a higher level of
accuracy is attained for detailed analysis
surrounding the actual election date.
We can clearly see that in the days
prior to the election, stock market
prices tend to increase sharply. In a sim-
ilar way, statistics show that markets
tend to be positive prior to holidays.
Apparently these two phenomena are
related. The backdrop is likely that the
mood tends to be positive before spe-
cial days as investors do not only make
rational decisions but rather emotional
ones as well. Likewise, prior to an elec-
tion the mood improves as people hope
for their candidate’s victory and fresh Dimitri Speck, Seasonal Charts

October 2008 THE TECHNICAL ANALYST 21

 Techniques

OBSERVATIONS ON
LUNAR PHASE &
US PANICS
By David McMinn

Is there a link between the moon and the markets?

An amazing correlation exists between the phase of the If we extend the timeframe back to 1910 and forward to the
moon and the timing of major US financial panics. Figure 1 present, we can add the events listed in Table 1
plots annual one day (AOD) falls1 greater than 4.25% for the
Dow Jones Industrial Average (DJIA) against the lunar cycle, AOD Fall Event DJIA
between 1915 and 1999. AOD falls in the DJIA greater than % Fall Phase Angle
4.25%2 have nearly always appeared in two quarter segments Jan 20, 1913 One day fall -4.90 153
of the lunar phase: between the first quarter and full moon Jul 30, 1914 Onset of WW1 -6.63 099
and between the third quarter & new moon, the only anom- Apr 14, 2000 Tech Wreck -5.64 130
aly being in 1930.3 Sep 11, 2001 WTC attack na 281
Jul 23, 2002 One day fall -4.64 122
LUNAR PHASE & MAJOR DJIA Jan 21, 2008 (a) Stock market panics na 169
ONE DAY AOD FALLS Sep 15, 2008 After Black Sunday -4.41 184
1915 - 1999 Sep 29, 2008 Bailout rejected -6.98 004
Table 1. (a) Worldwide stock market panics occurred on this day.
The US stock market was closed for the Martin Luther
King Jr holiday.

Of the total 31 major DJIA AOD falls (> 4.25%) since

Figure 1. LUNAR PHASE & MAJOR DJIA AOD FALLS 1915 –
1999. Note: The angular degree (Ao) between the moon and the
sun (lunar phase) increases on the chart in an anti-clockwise
direction, i.e. 90 degrees is equivalent to South on the chart and
270 degrees is equivalent to North.
1910, only the 1930 event did not occur when lunar phase
was within the two quarter segments noted in the diagram,
(ranges: 085 to 185 Ao and 280 to 005 Ao). This finding is
extremely significant and would be equivalent to tossing a
coin 31 times and getting 30 heads. However, it’s worth not-
ing that this lunar phase effect does not apply before 1910 or
to DJIA AOD falls below 4.25%. It also does not show up
in FT-30 daily data post 1935.
One obvious question arises: Why does a correlation exist?
Presumably it has something to do with moon sun tidal →
1 The annual one day fall is the biggest one day % fall in the year
commencing March 1.
2 The -4.25% cut off was chosen from the data. For one day falls less
than this there was no significance.
3 This diagram was first presented by myself in 2000 and published
by the Australian Technical Analysts Association: McMinn, David.
Lunar Phase & US Crashes. Australian Technical Analysts Assoc
Jour. p 20, Jan/Feb 2000.

22 THE TECHNICAL ANALYST October 2008

 Techniques

harmonics, although how this functions remains unknown. Where are we now?
And whilst it’s true that correlation does not equal causation, The 2007 to 2008 market crisis has historic parallels. The
these and many other correlations support a strong moon record DJIA high occurred on October 9, 2007, which was
sun affect on market activity. Such findings confirm the idea close to the September highs in 1895, 1899 and 1912. Each
that markets are cyclical and past activity is indeed indicative of the four highs was followed by a major crash 104 to 112
of future outcomes. days later (see Table 2) and a protracted market decline there-
If you list DJIA market highs by the year, they will not cor- after.
relate with lunar phase. However, if you list the highs by Market Interval 1 Day Fall
month – day (year ignored) excellent relationships can be High > 4.50% Interval Low
established. If the peaks at the beginning of a bear market
occur around the same month, the moon ans sun will be in 1895 (a) 107 days 1895 (a) 232 days 1896
similar ecliptical segments, giving rise to similar lunar phases Sep 04 Dec 20 Aug 08
and market outcomes. The best example occurs for the
September 3, 1929 and August 25, 1987 peaks, both of which 1899 104 days 1899 280 days 1900
took place just after the new moon and both were followed Sep 05 Dec 18 Sep 24
55 days later by spectacular October panics. The violent mar-
ket decline lasted only a few months, with the DJIA hitting a 1912 112 days 1913 556 days 1914
bottom on November 13, 1929 and December 4, 1987. For Sep 30 Jan 20 July 14
1929 and 1987, there was an interval of 717.0 lunar months
between the spring lows, the record highs, the autumn highs, 2007 104 days 2008 (b) ??? ???
the panics, the recoveries and the major post crash one day Oct 09 Jan 21
falls (Carolan, 1998, McMinn, 2006).
Curiously, major events in the current market have taken
place near the full and new moons (to within a day). Thus,
intervals between the events were all in whole and half num-
bers of lunar months.

DJIA World Black Black

Peak Panics Sunday Monday

2007 2008 2008 2008

Oct 09 + 3.47 Jan 21 + 8.03 Sep 14 + 0.51 Sep 29
346 A° 169 A° 172 A° 004 A°
Table 2. (a) Based on the 12 Stock Average index.
(b) This date witnessed worldwide stock market panics,
although the US market was closed because of the Martin
Luther King Jr holiday. Even so, January 21, 2008 has been
taken as the DJIA one day fall.

We are now going through the long bear market period.

Unfortunately, timing the final low using past analogies is dif-
ficult. As can be seen in Table 2 the interval between the one
day fall and the market low ranges from 232 days to 556 days,
which is not helpful. However, picking the low in the current
turbulent market will have immense financial rewards.

References
Carolan, Christopher. Autumn Panics. The Market
Technician. Journal of the Society of Technical Analysts. p
12. July 1998.
McMinn, David. Market Timing by the Moon & the Sun.
Privately published. 2006.
© Copyright 2008. David McMinn. All rights reserved.
www.davidmcminn.com

October 2008 THE TECHNICAL ANALYST 23

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Stumbling on
Techniques

Value Investing
Behavioural biases play a dual role in the markets. Firstly, they can be viewed as
the biases that a trader or investor should try to avoid in order to take a more
rational and disciplined approach. Secondly, they can be viewed as the biases that,
en-masse, are played out in the market and can be exploited for profit. In this arti-
cle, The Brandes Institute looks at some of the most common biases that prevent
investors from taking a purely rational value-based approach.

Stumbling on Happiness1 is a book by Daniel Gilbert, Harvard “Presentism” in the Past

University professor of psychology, about “the foibles of
imagination and illusions of foresight that cause each of us
to misconceive our tomorrows and misestimate our satisfac-
tions.”
So what does Stumbling on Happiness have to do with value
investing? First, many studies have illustrated the potential
benefits of value investing. The value investing approach
hinges upon taking advantage of discrepancies between a
security’s price and its underlying value. Value investors tend to
purchase a security when it is out of favor and selling at a dis-
count to its true or “intrinsic” worth. Then, as other
investors recognize this value, the price of the security typi-
cally rises. The Brandes Institute has published research
reports (such as our “Value vs. Glamour” series) that echo
the findings of various academics and illustrate the merit of
value investing. Value investing sounds simple – and has been
shown to work. So why don’t more people adhere to this
approach?
Using excerpts and examples from Gilbert’s book, this arti-
cle seeks to illustrate a variety of psychological pitfalls that
may prevent people from achieving long-term success as
value investors. The titles for each section are borrowed from
chapter titles or subheadings in Gilbert’s book. We begin
with presentism.
Gilbert defines presentism as “the tendency for current expe-
rience to influence one’s views of the past and the future”.
For investors, this tendency points to the dangers of extrap-
olation. We may find it difficult to believe that a security
whose price has gone up recently could ever be a bad invest-
ment. Conversely, we may have trouble envisioning a securi-
ty that has been a poor performer recently ever being a good
investment. Value investors need to counter the tendency to
extrapolate what is happening today and look at things
rationally by comparing business values with security prices.
This may sound reasonable – until we realize that the very act
of making comparisons may trigger some behavioral traps.
Comparing and Presentism
Gilbert points out that how we make comparisons affects our
emotional response. And this may influence our decisions.
He writes, “. . . (a) value is determined by the comparison of
one thing with another; (b) there is more than one kind of
comparison we can make in any given instance;
and (c) we may value something more highly when we make
one kind of comparison than when we make a different kind
of comparison”. Often, market participants may get into →
1 Gilbert, Daniel. Stumbling on Happiness. New York: Knopf, 2006.

October 2008 THE TECHNICAL ANALYST 25

 Techniques

“WE END UP PREFERRING
BAD DEALS THAT HAVE
BECOME DECENT DEALS TO
GREAT DEALS THAT WERE
ONCE AMAZING DEALS”
trouble when they “compare with the past” by comparing a
security’s current price with its past price. Many investors
“anchor” on the purchase price for a security. For example, if
they buy a stock at $40 a share, they constantly compare its
performance with that original cost. Thus, if the stock price
drops to $30, they tend to get upset. But looking at a stock’s
current price vs. its purchase price is only one way to make a
comparison. If the value of the business remains $70 per
share, a decline to $30 represents an even greater discount –
and perhaps an opportunity to purchase additional shares.
In an example, Gilbert writes that “. . . people are more
likely to purchase a vacation package that has been marked
down from $600 to $500 than an identical package that costs
$400 but that was on sale the previous day for $300. Because
it is easier to com-
pare a vacation pack-
age’s price with its
former price than
with the price of
other things one
might buy, we end up
preferring bad deals
that have become
decent deals to great
deals that were once
amazing deals”.
Disambiguating
Experience
There is an old Wall
Street adage, “Never
get emotional about stock.” Great advice – but very difficult
to put into practice. According to Gilbert, there is a reason
why we tend to get emotional – our brains take life’s ambigu-
ities and reshape them into “good” things or “good” experi-
ences once we are personally involved. A stock in the United
States, one of thousands of securities we could own, is rather
ambiguous – until it’s in our portfolio. At that point, investors
may get emotional about their holdings. According to
Gilbert, “. . . as soon as we have a stake in its goodness – our
brains get busy looking for ways to think about the experi-
ence that will allow us to appreciate it”. As examples, Gilbert
cites studies in which consumers, job seekers, high school stu-
dents, gamblers, and voters rated their appliances, jobs, col-
leges, horses, and candidates more positively after they pur-
chased, accepted, enrolled in, wagered on, or voted for them,
respectively.
Challenging Facts
Once we have formed an opinion about something, it can be
difficult to change it. Often, our perceptions and hypotheses
become our realities – regardless of the facts. Gilbert notes
we tend to treat facts “unevenly” when confirming or chal-
lenging “our favored conclusion” and cites a study to illus-
trate this point. Volunteers were asked to judge the intelli-
gence of another person.
When the person being evaluated was perceived to be
“funny, kind, and friendly,” little evidence was required.
However, if the person being evaluated was perceived to be
“unbearable,” volunteers required much more evidence.
Thus, when we want to believe something, just a few facts can
convince us. As such, people would be wise to actively seek
out information that counters our conclusions when making
investment decisions. And we should seek a great deal of this
countering information.
Valuing Things Differently
Why can it be so hard to be a patient investor? Gilbert may
offer some insight when he writes, “The fact that we imagine
the near and far
futures with such dif-
ferent textures causes
us to value them dif-
ferently as well”. He
cites an example of
paying for a
Broadway show tick-
et. Most people
would be willing to
pay more for a ticket
to a show tonight
than a ticket to the
same show next
month. “Delays are
painful,” he writes,
“and it makes sense
to demand a discount if one must endure them.” But he adds
that studies show when people imagine the pain of waiting,
they expect it to be far worse in the near term vs. the long
term. “And this,” Gilbert contends, “leads to some rather odd
behavior”. For example, most people would rather get $20 in
a year than $19 in 364 days. Apparently, a one day delay that
takes place in the far future looks (from here) to be a minor
inconvenience. But – most people would rather receive $19
today than $20 tomorrow because a one-day delay that →

26 THE TECHNICAL ANALYST October 2008


takes place in the near future looks (from here) to be unbear-
able.
“Whatever amount of pain a one-day wait entails,” Gilbert
writes, “that pain is surely the same whenever it is experienced;
and yet, people imagine a near-future pain as so severe that
they will gladly pay a dollar to avoid it, but a far-future pain as
so mild that they will gladly accept a dollar to endure it”.
Value investing likely will not trigger that part of our brain
that generates feelings of pleasure in the short term. (Such
feelings of excitement help drive gamblers into casinos, not
into value managers’ offices). Value investing often doesn’t
feel exciting or pleasurable. That’s because it’s not a short-
term, get-rich-quick approach to the markets. But it is impor-
tant to know that our short-term emotional responses can
affect our long-term rationality.
The Least Likely of Times
People tend to remember specific, infrequent experiences. We
tend to remember the best and worst of times vs. most of the
times. And this can affect decision-making. For example,
Gilbert highlights how our reaction to the way a movie ends
influences our perception of the entire film. “The fact that
we often judge the pleasure of an experience by its ending
can cause us to make some curious choices”. There are par-
allels when investing: We might tend to remember with
greater clarity the bad investments we have made – especially
if they have happened recently and ended with great pain
(large losses). The sharp emotions connected with these
short-term experiences may affect our long-term investment
approach.
Paradise Glossed
Perhaps we have heard the theory that negative events can
have twice the emotional effect as positive events. For exam-
ple, a $10,000 investment gain might earn us one “point” on
an emotion based scale. However, losing $10,000 when
investing would feel like losing two points. Same amount of
money involved – but twice the emotional impact when los-
ing money. This may be true, yet Gilbert argues that the
human spirit is very resilient. He writes, “The fact is that neg-
ative events do affect us, but they generally don’t affect us as
much or for as long as we expect them to”. So this is great
news, right? So why do we still have such trouble focusing on
the long term? The answer: we continually subject ourselves
to an assortment of short-term stimuli.
Successful value investors may remember a handful of
clunkers, but, over time, the short-term emotional pain asso-
ciated with these few holdings fades when they realize their
long-term success. Yet it can be difficult to shed the emotion-
al drag of short-term pain when we expose ourselves to it so
frequently.
Looking Forward to Looking Backward
Gilbert uses two investment scenarios to illustrate the influ-
ence of regret:
October 2008
Techniques
1. You own shares in Company A. During the past year, you
considered switching to stock in Company B but decided
against it. You now find that you would have been better
off by $1,200 if you had switched to the stock of
Company B.
2. You also owned shares in Company C. During the past year
you switched to stock in Company D. You now find out
that you’d have been better off by $1,200 if you kept your
stock in Company C.
VOLUNTEERS WERE ASKED TO
JUDGE THE INTELLIGENCE OF
ANOTHER PERSON. WHEN THE
PERSON BEING EVALUATED WAS
PERCEIVED TO BE “FUNNY, KIND,
AND FRIENDLY,” LITTLE EVIDENCE
WAS REQUIRED. HOWEVER, IF
THE PERSON BEING EVALUATED
WAS PERCEIVED TO BE “UNBEAR-
ABLE,” VOLUNTEERS REQUIRED
MUCH MORE EVIDENCE.
Which scenario causes more regret? Nine out of 10 people
expect to feel more regret by switching. But Gilbert notes, “. .
. in the long run, people of every age and in every walk of life
seem to regret not having done things much more than they
regret things they did. . . ”. Thus, not switching stocks (scenario
1) causes more emotional stress. Why? We tend to reward our-
selves mentally for taking action – even if it’s the wrong action.
Our “psychological immune system” has trouble making us
feel good about inaction. In other words, doing nothing rarely
feels very good. This is another reason why value investing
can be so difficult. Often, long-term success depends upon
inaction. But not taking action may trigger sharp pangs of
regret – especially in the short term if prices for holdings
decline. The successful value investor may have to wait three
to five years or more to be rewarded. That can be a long time
to “do nothing,” a long time for regret to build.
Brandes Institute Research Paper No. 2007-05, August 2007. This
material was prepared by the Brandes Institute, a division of Brandes
Investment Partners®. Please visit www.brandes.com/institute for the
full version, (also available from www.ssrn.com).
THE TECHNICAL ANALYST 27
 Techniques
VOLATILITY TRADING
USING THE VIX
By Carley Garner
The adage ‘buy low and sell high’ was originally used in refer-
ence to price, but can also be applied to the practice of trad-
ing volatility. In fact even if you do not trade volatility ignor-
ing measures of potential explosiveness while entering or
exiting a market could mean financial peril. While many
traders understand the concept of buying options during
times of low volatility and selling them during times of high
volatility, emotions often lead a well planned strategy astray.
Unlike traders that are looking to profit from a directional
move in price, volatility traders are more interested in the
pace at which the market is moving than in its direction.
However, it is important to chart both price and volatility.
Doing so provides trades with a better understanding of the
'big picture'.
In my opinion, the most efficient means of trading US
equity market volatility isn't through the VIX index or any
other similar measure. Liquidity is a major factor working
against the viability of doing so. Instead, I believe that traders
should look to buy or sell options on S&P 500 futures. The
S&P is a broad based index and its value is sharply impacted
by market sentiment and the corresponding volatility. Thus, a
trader that is of the opinion that volatility will increase may
look to buy volatility through the purchase of options writ-
ten on S&P 500 futures, and those looking for volatility to
decrease may look to sell volatility by going short options on
the index.
Trading Volatility through Premium Collection
As mentioned, one way to speculate on variations in volatili-
ty is through the practice of option selling, often referred to
as premium collection. Option sellers are in the business of
collecting premium, much like an insurance company, under
the assertion that in the long run the premium collected
should outweigh any potential payouts. This theory is based
on the assumption that more options than not
expire worthless which has been suggested by several studies
including one conducted by the Chicago Mercantile
Exchange. Unfortunately, just as insurance companies are
sometimes forced to honor their policies on excessive claims,
option sellers are vulnerable to monster market moves than
can be potentially account threatening. Preventing such disas-
28 THE TECHNICAL ANALYST October 2008
ters ultimately comes down to timing of entry along with a
good understanding of volatility, market sentiment and mar-
ket knowledge. Additionally, experience, instinct and, of
course, luck will also come into play. Yet, in my judgment
option selling is a superior strategy in the long run.
Options selling advocates and equity market volatility
traders seem to migrate to the S&P 500 futures market. Both
the full sized and mini versions of the contract provide ample
liquidity to actively trade the market without the burden of
unreasonable bid/ask spreads.
CBOE's Volatility Index (VIX)
An important measure of volatility when referring to the
S&P is the now infamous Chicago Board Options
Exchange's Volatility Index, often simply referred to as the
VIX. According to the CBOE, the VIX is a "key measure of
market expectations of near-term volatility as conveyed by
S&P 500 stock index option prices" and has become one of
the most prominent measures of market sentiment in the
world. Before 2007 the VIX spent a majority of its time
below 20, it is now obvious that times have changed....at least
for now.
Keep in mind that there were adjustments made to the
parameters of the index in 2003 that may have arguably
affected the value of the index. For our purposes we will dis-
regard the possible discrepencies.
It is important to note that increased values of VIX are
highly correlated with higher option premium in the form of
higher implied volatilities and are ideal conditions for an
experienced option seller assuming that they are willing to
accept the risk of participating in such a market.
The Quest for Implied Volatility
Unlike the VIX which is derived from the underlying futures
price among other factors, implied volatility is a component
of option price. The implied volatility of an option, is the
amount of volatility implied by the market value, or price, of
the option. In other words, the implied volatility is forward
looking in that it incorporates the current market precarious-
ness as well as what market participants are expecting at some
point in the future.

You may also find that market emotion and sentiment are
a component of implied volatility. As traders scramble to go
long volatility through the purchase of options in an attempt
to profit from the latest hype, option premiums can and do
explode exponentially. As a sidelined option seller, these
types of conditions should be inviting. The premise of this
approach is to attempt to sell options to buyers that are sim-
ply "late to the party". The key is making sure that as a sell-
er you aren't too early.
Selling Puts can be Lucrative, but it Comes with
a Hefty Price Tag
It is often the case that selling puts is more lucrative than
calls, but the added reward carries baggage in the form of
additional risk. Due to the increased levels of risk, timing
becomes crucial. By nature an option selling program tends
to leave room for error in the execution. Nonetheless, being
short puts in a spiraling market can quickly change that.
The phenomenon of put premium in the stock indices
being larger than call premium is often referred to as the
volatility smile. The volatility smile is a long observed pattern
in which at-the-money options have lower implied volatility
than out-of-the-money options along with the argument that
there is more value in owning a put relative to an equally dis-
tant call. This scenario seemed to be born after the crash of
1987 in the U.S.
While there are no crystal balls to let us know when a mar-
ket will turn around and how low that it may go before it
does, being aware of historical patterns in price, volatility and
market sentiment may help to avoid a compromising situa-
tion. Let's take a look at the relationship between the VIX
and the S&P.
Figure 1.
VIX and the S&P 500
Looking at Figure 1, it is obvious that the S&P 500 has been
able to forge recoveries during times of spiked volatility as
measured by the VIX. Armed with this knowledge, it may be
a viable strategy to look at erratic, and many times irrational,
trade as a point of entry for put sellers.
October 2008
Techniques
For example, based on this assumption put sellers may
have fared well during the lows in 1998, 2001, 2003 and 2007.
That is of course assuming that the trader wasn't early in his
entry. If a short volatility trader enters a market prematurely,
there is a strong possibility that the trader will be forced out
of the market prematurely due to lack of financing or mar-
gin. Let's take a look at an example of a trader that is inter-
ested in selling volatility by going short S&P puts.
Beginning in the middle of 2002 and throughout the begin-
ning of 2003, put sellers with savvy timing may have done
very well. However, trading is a game of risk and those sell-
ing puts during those times were accepting great amounts of
risk in order to reap the reward.
Let's take a look at a continuous S&P 500 futures chart
during the 2002/2003 lows in Figure 2. While the VIX is a
great indication of volatility and extreme market sentiment, it
is also helpful to look at indicators of volatility such as stan-
dard deviations. Luckily, the creation of Bollinger Bands
allows us to visually determine market volatility through the
line plot of two standard deviations from its mean. Times of
high volatility are denoted by wider bands, or a larger stan-
dard deviation, and times of decreasing volatility result in
narrowing bands.
As market volatility increases, so will option prices. During
such times, option buyers are forced to pay extremely high
prices for options that in theory are more likely to expire
worthless than not. On the other hand, option sellers are pro-
vided top dollar for accepting theoretically unlimited risk.
"IT IS
IMPORTANT TO
CHART BOTH
PRICE AND
VOLATILITY."
Higher premiums collected not only increase a traders
profit potential but it also increases the room for error. The
money collected for a short option can be viewed as "cush-
ion" in that it defines the amount in which the trader can be
wrong and still make money by shifting the reverse break
even further from the market. The Reverse Break Even
(RBE) of a short put is calculated as follows:
THE TECHNICAL ANALYST 29
 Techniques

Figure 2.
RBE = Put Strike Price - Premium Collected +
Commissions and Fees
As you can see, the more money that the option seller col-
lects, the deeper-in-the-money the option can be at expira-
tion without resulting in a loss to the trader.
According to the hypothetical data available to us, in July of
2002 with the September futures price near 780, it may have
Figure 3.
At expiration, this trade would yield the maximum profit of
$1,075 before commissions and fees if the futures price is
above 680 (see Figure 3). Ignoring transaction costs the RBE
on the trade is at 675.7. This simply means that this particu-
lar trade makes money with the futures price trade anywhere
above 675.7 before commissions and fees. Please note that
the amount of commission paid will reduce the premium col-
lected and shift the RBE closer to the market. To look at it in
another perspective, the trader can be wrong by 104.3 points
after entering the trade and still manage to break even. If the
trader's goal is to put the odds in their favor, this seems to be
the solution.

Conclusion
Without regard to transaction costs, trading is a zero sum
"THE S&P 500 HAS game; for every winner there will be a loser. Thus, putting
your odds ahead of those of your competition is a must. In
BEEN ABLE TO my opinion, selling options during times of high volatility
while exercising patience and incorporating experience is
doing just that.
FORGE RECOVERIES With that said, where there is reward there is risk; in effi-
cient markets you cannot have one without the other. This
strategy should only be attempted by those that have ample
DURING TIMES OF risk capital to allow for potential draw downs as well as the
ability to manage fear and greed. Fearful traders are vulnera-
ble to panic liquidation at inopportune times in terms of
SPIKED market volatility and option pricing. Likewise, greedy traders
are tempted to sell options closer-to-the-money in hopes of
VOLATILITY." higher payouts but the risk may turn out to be unmanageable.
I strongly believe that less is actually more when it comes to
premium collection. Trade less, collect less and hopefully
enjoy more success.
been possible to sell the August S&P 500 futures 680 put for
$4.3 in premium which is equivalent to $1,075 before com- Carley Garner is the Senior A nalyst of DeCarley Trading LLC where
missions and fees. If this was the case, a trader could have she also works as a broker. Her book, "Commodity Options" published
collected a little over a thousand U.S. dollars for an option by FT Press will be on shelves in January 2009. V isit
that was, at the time, approximately 100 points or nearly 13% www.DeCarleyTrading.com for your free subscription to Carley's e-
out-of-the-money. newsletters and for details on the services she provides.

30 THE TECHNICAL ANALYST October 2008

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TD-Wave
Techniques

- A rule based approach to Elliott Wave analysis

By Trevor Neil

Tom DeMark is adamant that subjective methods used in technical analysis can-
not be trusted. When technical analysts cannot agree amongst themselves how to
draw them, how can they be tested and how can be people be confident in using
them? Perhaps the most subjective of all technical analysis methods is Elliott
Wave analysis. There is a joke amongst technical analysts - bring together five
Elliott wave analysts and you will get ten views on the markets. Yet all these ana-
lysts use the same technique with the same rules.

Tom has distilled this technique into a strict set of rules and measurements, so
strict that a computer can calculate them and display them, marking up the wave
counts according to defined rules. With his rules, everyone sees the same thing and
makes the same correct count (if you agree with his rules). Elliott wave is now
objective and mechanical - This is Tom DeMark’s D-Wave.

D-Wave rules Conversely, wave 1, 3, 5, and B counts require that the

D Wave constructs Elliott cycles with user defined wave
counts. The trend cycles develop with five impulse waves
followed by a counter trend pattern of three corrective
waves. The recommended D Wave settings suggest the
waves 1, 3, 5 will become increasingly more significant in
the development of the overall trend. The wave 1, 3, 5, and
B counts require that the user specified price (high, true
high, close) must be higher than the previous 'N' number of
bars: the 2, 4, A, and C counts require that the specified
price (low, true low, close) must be lower than the previous
'N' number of bars in an upward trend.
user specified price (low, true low, close) must be lower than
the previous 'N' number of bars, while the 2, 4, A, and C
require that the specified price (high, true high, close) must
be higher than the previous 'N' number of bars in a down-
ward trend.
D-Wave uses patterns that are defined by a series of
Fibonacci highs and lows. This approach makes a D-Wave
objective, e.g. Wave 1 could be identified as an 8 bar high, a
high higher than all previous 7 bars' highs. The succeeding
waves 2, 3, 4, and 5, as well as the correction waves, use
Fibonacci numbers. →

32 THE TECHNICAL ANALYST October 2008

 Techniques

D-Wave displays waves according to the following logic: Screen shots of D-Wave on Bloomberg

For Up-Waves,
High of 1 is less than the low of 4, and
High of 1 is less than the high of 3, and
High of 3 is less than the high of 5.

For Down-Waves,
Low of 1 is greater than the high of 4, and
Low of 1 is greater than the low of 3, and
Low of 3 is greater than the low of 5.

Level / Price,
Wave Start-21 Low
Wave 1-8 High DeMark D-Wave for the S&P500
Wave 2-5 Low
Wave 3-13 High Wave Properties
Wave 4-8 Low
Wave 5-21 High
Wave A-13 Low
Wave B-8 High
Wave C-21 Low
The reverse logic applies for sells.

Price Projections
Price projections are created based on the length of a wave
and Fibonacci extensions. To calculate the projection, you
must obtain the difference of the prices between waves.
Obtain the difference between the "Wave Validation" prices -
the "From" and "To" waves, then multiply that value by the
Fibonacci number in the "Times" category. The resulting
value is then added to the "At" wave start for an Up wave
and subtracted from the "At" wave start for a down wave.

Example
To calculate the Wave 3 Objective, take the difference
between the start and end of Wave 1 equalling 10 points.
The difference is then multiplied by 1.618, resulting in a
value of 16.18. In a down sequence, this value would be
deducted from the start of Wave 2, equalling 40 in the
above example. The Wave 3 price objective would be 23.82.
As always with Tom DeMark’s work, the most valuable ben-
efit of using this indicator is to help you identify low-risk
buy and sell trading zones. D-Wave takes a difficult and
highly subjective technique and turns it into a rule-based
method. It offers the flexibility of deciding what and how
you want the rules to be enforced but then will accurately
implement them.

Trevor Neil is CEO of Betagroup and head of training at

the Technical Analyst.

For further information on D-Wave, please refer to Thomas

R. DeMark’s book, “The New Science of Technical
Analysis”, (New York: John Wiley & Sons, 1994).

October 2008 THE TECHNICAL ANALYST 33

 Techniques

34 THE TECHNICAL ANALYST October 2008

 Techniques

SIZING UP A SUPERPOWER:
A SOCIONOMIC STUDY OF RUSSIA
By Alan Hall

Elliott Wave International analyst, Alan Hall, uses Robert Prechter's principle
of Socionomics to tie events in Russian history to Elliott Wave cycles, and
explains why his analysis has serious implications for Russia and its neighbours
going forward.

Looking Back: Russian History through a

Socionomic Lens
Russian history is a story of extremes — from battleground
to superpower and back to second tier state, from totalitari-
anism to dysfunctional democracy, from Gulag to glasnost,
and from communism to a mixed economy. Politics and
social landscapes tend to wax and wane along with the wave
pattern. A stock market would certainly have reflected
Russia’s extreme social swings had the Kremlin allowed one.
Stock market data provide an objective measure of the rela-
tive optimism and pessimism of investors, so they serve as
our primary indicator of social mood. Although there is no
pre-1995 Russian stock market data, we observe that events
in Russia have correlated well with the social mood of the
U.S., as illustrated by trends in U.S. stock prices, which to a Figure 1.
substantial degree are correlated with social mood worldwide.
A brief historical review will give some perspective. (See 1892 generated no major conflicts and only one war, the brief
Figure 1) Russo-Turkish War, from 1877 to 1878. (Note the pullback in
the middle of wave III.) This period of relative peace is what
1859-1892: Cycle Waves I, II and III we expect from third waves.
The bear market of the 1850s produced the Crimean War
(1853-1856), which devastated Russia. With 256,000 dead, 1892-1920: Cycle Wave IV
Grand Duke Konstantin Nikolayevich said “… we are both The wave IV bear market caused increasingly negative social
weaker and poorer not only in material but also in mental expressions in Russia. The years 1901 through 1903 saw a
resources, especially in matters of administration.” steady increase in peasant revolts, in which mobs burned
Positive events began in 1861 as wave I unfolded. Tsar manor houses and mutilated animals. The Russo/Japan war
Alexander II emancipated the serfs in an attempt to relieve was initially popular in 1904 but ended in crushing defeat.
revolutionary pressures and move Russia out of its feudal The Russian Revolution of 1905 brought nominal reforms by
economy. Living conditions for the peasants remained unfa- the Tsar, followed by a crackdown in 1906. The Tsar declared
vorable, however. absolute executive power, then disrupted revolutionary
The wave II bear market produced several uprisings and a groups and imprisoned or exiled the groups’ leaders.
capitulation. In 1864, Alexander declared the end of the long By 1913, deep into wave IV, the average Russian was earn-
Caucasian War (1817-1864). ing 27 percent of an average Englishman’s wages and paid
The positive social mood that drove wave III from 1865 to 50% more in taxes. The Cycle-degree global bear market →

October 2008 THE TECHNICAL ANALYST 35

 Techniques
and the decaying tsarist autocracy exacted terrible social costs.
Russia had the highest mortality rate in Europe and a lower
literacy rate than England 163 years earlier in 1750.
The effects of negative social mood worldwide led to
World War I in 1914. By its end, 3.3 million Russians had
died, by far the largest death toll of any combatant nation.
The massive social and political chaos at the end of wave IV
decimated manufacturing, foreign trade, agricultural produc-
tion and Russia’s already poor per capita income, which fell
over 70 percent.
Radicalism tends to emerge and become entrenched in cor-
rective waves. Marxism was Cycle wave IV’s radical idea. It
encouraged the Russian Revolution of 1917, which ended the
reign of the Tsars and eventually led to a savage civil war.
In 1918, as the five-year civil war wore on and wave IV
approached its nadir, Lenin narrowly survived an assassina-
tion attempt. Shortly afterward came the successful assassina-
tion of a secret-police chief. Lenin then instituted a policy of
open and systemic mass terror. His handwritten “Hanging
Order” of August 11, 1918 began the “Red Terror” cam-
paign. This edict illustrates how a bear market of
Cycle degree accommodates Russia’s tendency toward
social extremes, in this case with fear, recrimination and
scapegoating:
11 VIII 1918
Send to Penza To Comrades Kuraev, Bosh, Minkin and other Penza
communists
Comrades! The revolt by the five kulak volosts must be suppressed with-
out mercy. The interest of the entire revolution demands this, because we
have now before us our final decisive battle “with the kulaks.” We need
to set an example.
1) You need to hang (hang without fail, so that the public sees) at least
100 notorious kulaks, the rich, and the bloodsuckers.
2) Publish their names.
3) Take away all of their grain.
4) Execute the hostages — in accordance with yesterday’s telegram.
This needs to be accomplished in such a way, that people for hundreds of
miles around will see, tremble, know and scream out: let’s choke and
strangle those blood-sucking kulaks.
Telegraph us acknowledging receipt and execution of this.
Yours, Lenin
P.S. Use your toughest people for this.
TRANSLATOR’S COMMENTS: Lenin uses the derogative term
kulach’e in reference to the class of prosperous peasants. A volost’ was
a territorial/administrative unit consisting of a few villages and sur-
rounding land. (Library of Congress, http://www.loc.gov/exhibits
/archives/ad2kulak.html)
Scholars estimate that Lenin’s campaign caused the execu-
tion of up to 200,000 people between 1918 and 1921. The
concurrent civil war took the lives of seven to eight million
people, five million of whom died by famine.
Overall, Cycle wave IV (1892-1920) wreaked tremendous
36 THE TECHNICAL ANALYST October 2008
economic and social damage. From 1914 to 1921, Russia’s
population crashed more than 22 percent. Industrial output
dropped 87 percent between 1913 and 1922, and gross crop
yield fell by more than half. From these depths wave V in
social mood emerged, but due to the form of government
that took over in wave IV, Russia’s recovery was much slow-
er than the rising social mood would have produced in a freer
society.
1920-1929: Cycle Wave V of Supercycle Wave (III)
In 1921, the year after the rise of wave V began, Lenin aban-
doned attempts at communal agriculture and allowed individ-
ual farming. The following year, the U.S.S.R. was formed. By
1926, agricultural output had returned to at least the pre-rev-
olution level of thirteen years previous, and industrial output
did so two years later. Compared to those in the West, most
economic recoveries in Russia look like half-hearted relief
rallies. That was certainly true of Supercycle wave (III), and it
left little for wave (IV) to draw upon.
"NEGATIVE SOCIAL THEMES DUE
TO APPEAR IN ANY APPROACHING
BEAR MARKET FIRST EXPRESS
THEMSELVES IN MILDER FORM IN
THE PRECEDING FOURTH WAVE OF
ONE LESSER DEGREE."
1929-1948: Supercycle Wave (IV)
The following quote describes how some points in the Elliott
wave pattern allow unique social forecasting:
Forecasting Styles of Social Events
Here is another esoteric point but one of great value. A section on
“Nuances” in Chapter 15 of The Wave Principle of Human Social
Behavior explains that negative social themes due to appear in any
approaching bear market first express themselves in milder form in the
preceding fourth wave of one lesser degree. Stop for a minute until you
get this idea. Here is a more detailed explanation: Social mood repeat-
edly traces out five waves up followed by three waves down. The negative
themes in “wave four” within the “fives waves up” presage those that
will dominate, more dramatically and on a much bigger scale, in the
ensuing “three waves down.”
It is also true of the character of social events. In an earlier fourth
wave from 1916 to 1921, collectivists took over Russia. In the larger
fourth wave that followed, from 1929 to 1949, collectivists took over
nearly half of the earth’s population, in Germany, Italy, Eastern
Europe and China. (The Elliott Wave Theorist, September 2001.)
Sure enough, the collectivism and social repression →

that emerged in Cycle wave IV (1892-1920) foreshadowed
what was to come in Supercycle wave (IV).
Even at the peak of Supercycle wave (III), the Soviet econ-
omy was unable to support the growth of industry and
armed forces. Foreign investors were not interested in the
country, and the middle class had been exterminated. Stalin,
who took power after Lenin’s death in 1924, had few sources
of revenue. He decided to plunder the 78% of the popula-
tion in the private agricultural sector. In 1929, at the onset of
Supercycle wave (IV), he began transferring control of farms,
equipment and livestock to the government.
Farmers considered this policy a return to serfdom. They
resisted and destroyed about half the U.S.S.R.’s livestock —
some 55 million horses and cows — whereupon Stalin
responded by sending about a million families into exile. This
conflict, and a catastrophic decline in grain production, exac-
erbated the famine of 1932-1933 that killed between five and
ten million people.
Stalin’s move to bring farmers under state domination
revealed the classic bear market trait of the desire to control
people. By most accounts, Stalin was rude, ruthless, unforgiv-
ing and without pity or empathy, and as the powerful wave
(IV) bear market accelerated, his malevolence expanded dra-
matically.
Stalin’s purges and deportations were a huge magnification
of Lenin’s “Red Terror” campaign of the preceding fourth
wave of one lesser degree. His massive social repression
spanned the period from 1929 to 1949, all of Supercycle
wave (IV). His purges were initially aimed at the most pros-
perous peasants (or “kulaks”) who resisted collectivization,
but they expanded into a genocide in which tens of millions
were starved, exiled or killed. This wave also amplified anoth-
er fixture of Cycle wave IV, the “katorga,” the predecessor of
the Gulag labor camp.
Supercycle wave (IV) ultimately gave rise to World War II.
The U.S.S.R. suffered the deaths of nearly 24 million civilians
and soldiers (13% of the population) at the hands of the
Axis.
The social environment today is so radically different that
few people can imagine the destructive power of a
Supercycle fourth wave. Photos of the kind that appeared in
1940s-era Life magazines — of the dead, wounded and gan-
grenous — simply are not published in any mainstream
media today.
Stalin executed millions of comrades and other
Communist Party members, officers and even heroes in
the Soviet Army — anyone who might have threatened his
power. He used fear, anti-Semitism, racial polarization,
starvations and secret police to consolidate his power so
firmly that no political opposition was possible. He used
scapegoats to cover his failures and re-wrote history
to his advantage. His police state forced Russians into sub-
mission. His impetus to “cleanse” society escalated into mass
hysteria, in which people denounced their neighbors, co-
October 2008
Techniques
workers and even parents. The economic costs
were immense, as the state killed the brightest or hauled
them off to the gulag. Fear stifled innovation, experimenta-
tion and constructive criticism and played a dominant
social role.
Fear is a key aspect of negative social mood. While democ-
racies typically oust leaders in bear markets, dictatorships
seem to thrive on bear market fear. Stalin died a natural death
in office in 1953 while apparently planning yet another purge
of top men in his government.
1948-1965: Supercycle Wave (V)
The upsurge in positive social mood in wave (V) pulled
Russia out of its worst depths. From the turbulence of
Supercycle wave (IV), the communist state engineered a
weapons and space program that gave it superpower status.
With Stalin gone, the Communist Party resurged. In 1953,
Nikita Khrushchev was confirmed as head of the Central
Committee, and change was in the air.
Social mood can make or break political careers, and the
politicians that thrive are either lucky or canny enough to ride
the winds of change. Prior to Stalin’s death in 1953,
Khrushchev was a devoted Stalinist. In the 1940s, near the
end of wave (IV), his participation in Stalin’s purges earned
him the nickname “The Butcher of the Ukraine.” But
Khrushchev would soon put this past behind him.
With perfect timing, in 1956, near the middle of wave I of
(V) in Figure 1, Khrushchev read a speech, “On the
Personality Cult and its Consequences,” denouncing Stalin
and weakening the Stalinists in the government. This marked
the beginning of the “Khrushchev Thaw,” a socially more
positive period in which the Soviets partially reversed repres-
sion and censorship, improved relations with the West and
released thousands of political prisoners from the Gulags.
During and just after Supercycle wave (V), the U.S.S.R. was
first in a number of critical space successes, including the
launch of Sputnik into orbit and the first space walk. The
U.S. and U.S.S.R.’s achievements in space were an astounding
expression of positive social mood that has not been equaled
in the 35 years since. In the list of positive aspects of social
mood in chapter 14 of The Wave Principle of Human Social
Behavior, we see the ones that made this achievement possi-
ble: adventurousness, clarity, confidence, constructiveness,
daring, desiring power over nature, embrace of effort, opti-
mism, practical thinking and sharpness of focus.
It’s no coincidence that the U.S.S.R.’s moon landing came
the year of the top in the powerful 1965 Supercycle wave (V)
peak in U.S. stocks. Three years later, as the achievements
deriving from a positive social mood peaked, the U.S. put
men on the moon.
1965-1982: Supercycle Wave (a)
Conciliation and inclusion characterize large degree wave
peaks, and the peak of wave (V) brought about a cluster →
THE TECHNICAL ANALYST 37
 Techniques
Figure 2.
of arms control treaties. 1964 also marked the first major U.S.
sale of grain to Russia. The superpowers adopted an attitude
of détente and they balanced in an uneasy truce.
Wave (a) was characterized by indirect superpower compe-
tition, mainly expressed in proxy conflicts in the third world.
The Soviets played a supporting role in wars in Vietnam,
Somalia, Angola, Mozambique, Laos, Cambodia and
Nicaragua, while the U.S. government countered with
materiel and support for military coups.
As both superpower economies contracted, their space
programs atrophied. The Soviet Union continued to suppress
dissent. In 1968 it sent about 500,000 troops into
Czechoslovakia to crush the Prague Spring and negate
reforms that had promised new freedoms of speech, travel,
debate and association.
In December 1979, the Soviets began their ill-fated war in
Afghanistan. The U.S. boycotted the 1980 Moscow Summer
Olympics, and the policy of détente became much less
relaxed.
In 1980, near the bottom of wave (a), the U.S. elected
Ronald Reagan on a platform opposed to détente. In 1983 he
gave his pivotal “Evil Empire” speech, describing the
U.S.S.R. as “totalitarian” and attempting to take the moral
high ground in the Cold War. This speech marked the end of
détente and a new period of change within the U.S.S.R.
1982-1999: Supercycle Wave (b)
Soon after wave (b)’s onset, the Politburo unanimously chose
Mikhail Gorbachev as General Secretary, and he began “per-
estroika,” a process of restructuring that weakened the
Communist Party’s grip within Russia. He also applied a pol-
icy of “glasnost,” meaning maximal transparency in the activ-
ities of the Soviet government. On November 9, 1989, dur-
ing the steepest ascent in wave (b), glasnost and freedom
came together, and the Berlin Wall fell in a global wave of
euphoria.
In 1991, during a recession at the end of Primary wave
((4)) in U.S. stocks, the KGB failed in a coup attempt against
38 THE TECHNICAL ANALYST October 2008
Gorbachev, and the U.S.S.R. collapsed. In Russia, economic
crisis followed. The result was a shattered economy, millions
of Russians pushed into poverty, pervasive political corrup-
tion, an explosion of organized crime and looting of state
assets. These developments were extreme given the small
degree of the mood change, but the decades of structural
damages ultimately deriving from the dark mood of 1917 had
left little infrastructure or social organization to cushion the
setback.
But the positive mood trend resumed, and Gorbachev
gave way to Boris Yeltsin, the first democratically elected
president of Russia. The country even developed a stock
market. The Russian Trading System Index (RTSI) formed in
1995 and immediately began an ascent to a peak in late 1997.
In 1996, in the heart of that bull market, Yeltsin won re-elec-
tion, with help from newly wealthy “oligarchs,” business
magnates. The First Chechen War was the only major Russian
conflict of the period.
The Russian financial crisis in August of 1998 accompa-
nied a global recession and a bear market in world commod-
ity prices at a time when Russia got 80% of its revenue from
oil, gas, metals and timber. Despite an IMF bailout, Russia
dramatically devalued the ruble to avoid default. Investors
fled the country and the RTSI fell below its starting level, tak-
ing Yeltsin’s popularity with it and bringing his previously tol-
erated buffoonery into sharp focus. Vladimir Putin then
inherited a young bull market and a new uptrend in Russia’s
social mood.
Elliott Wave Forecast
Figure 2 is a chart of the Russian Trading System Index from
its inception. Our Elliott wave count in the RTSI showed in
November 2007 that a clear five-wave advance beginning in
1999 was near completion. During this time, the RTSI
increased by sixty-fold. As expected, this index has begun its
biggest bear market since the five-wave pattern began. The
minimum probable drop — a move into the area of the
fourth wave of 2004 — would more than halve the value of
the index.
Such a decline should produce financial and social events
of a character comparable to those seen during comparable
declines in the past. Viewed in the context of Russian histo-
ry, this outlook has serious geostrategic implications.
Recent events do seem to foreshadow the expected social
character of the ensuing contraction. They suggest that a
bear market in Russia should be taken very seriously.
Social Signs of Coming Political Danger
When social mood shifts from bullish to bearish at a large
degree of trend, people need to protect their assets and
ensure their livelihood and safety in advance. This requires
anticipation of major change, a difficult task due to the
human psychological tendency to envision the future by
extrapolating the present. Used correctly, the Wave Principle
allows a certain degree of anticipation: →

The Wave Principle guarantees reliable forecasting only of probabilities.
It allows us to predict some aspects of the future and not others. For
example, early in a new social mood trend, we can forecast society’s com-
ing character changes but not necessarily specific events. We can forecast
that a major rising impulse wave will bring an increase in goodwill and
productivity. The specific decisions that each man makes and the specif-
ic social actions and events that result depend upon countless details and
are therefore chaotic. As the trend progresses, however, we can watch for
signs to indicate such specifics and actually anticipate some of them quite
well, as demonstrated in Chapter 17. (The Wave Principle of Human
Social Behavior, Robert R. Prechter, Jr. New Classics Library, 1999.
Chapter 20, p. 404.)
Russia in positive mood. Putin’s approval rating is
nearly 80%.
Russia seems more ready to confront the U.S. today than at
any time since the Cuban Missile Crisis, 45 years ago. Indeed,
on October 26, Putin made a comparison to that dangerous
time, reversing the protagonists’ roles, with the U.S. this time
placing missiles at Russia’s doorstep via the European missile
defense shield. The steadily increasing potential for conflict
between the two superpowers represents the potential for
serious trouble. On November 20, Putin warned that Russia
will react to a NATO military buildup on its borders. (BBC)
Social mood change at large-degree turns is not instanta-
neous. It can seem broad and slow as it develops. Recent top-
ics in the news that show how Russia is converting its new-
October 2008
Techniques
found prosperity into a growing military confidence include
the recent conflict with Georgia, resumption of bomber
flights along the US East Coast, a new air defense system,
new offensive weaponry such as nucleur submarines and
ICBMs, and recent announcements that the Russian Navy
will return to the Mediterranean Sea through a port in Syria.
In 1999, Putin told the Russian Federal Security Service
(FSB), “A few years ago, we succumbed to the illusion that we
don’t have enemies and we have paid dearly for that.” One
spokesman described Russia’s changing mood this way: “In
Gorbachev’s time Russia was liked by the West and what did
we get for it? We have surrendered everything: Eastern
Europe, Ukraine, Georgia. NATO has moved to our bor-
ders.” (Economist)
Social Implications
The stock market is our best indicator of social mood, so a
stock market forecast is first a social mood forecast, which
implies a commensurate change in the social environment.
Wave IV from 1892 to 1920 in Figure 1 retraced about 30
percent of the previous wave III that began in 1865. Wave
(IV) from 1929 to 1948 retraced about 40 percent of the pre-
vious wave (III) that began in 1859. Those declines accompa-
nied the extreme Russian social history described earlier.
They brought intense social repression, redirection of capital
from infrastructure to weaponry, and war and death on a
massive scale. Although the coming bear market has started
from a much higher point, realization of our forecast for a
large-degree decline in the RTSI will have major negative
effects on Russia, her neighbors and perhaps the rest of the
world.
A long-term trend toward a positive social mood leads to
peace and political cooperation, and an extreme trend change
in social mood toward the negative yields turmoil. A situation
where social mood in both the U.S. and Russia is in decline
would be quite different from the Cold War that occurred
during a bull market.
Russia’s long history of border wars and its desire to
reclaim the resources of satellite states lost upon the collapse
of the U.S.S.R. make future border conflicts likely. NATO,
Muslim and Asian countries border Russia on the west and
south. The ethnic diversity within these states represents con-
flicts-in-waiting for the xenophobia that attends bear mar-
kets.
Much as investors descend a “slope of hope” in a bear
market, we can expect the popular media to continue to
underestimate the seriousness of Russia’s steady resurgence
to the world’s second largest military power. One should
remain alert to the patterns unfolding in the stock markets,
the primary indicators of this social mood progression, and
to social and political events in Russia.
Extracted from A lan Hall, November 2007, “Sizing up a
Superpower: A Socionomic Study of Russia”, Parts I & II, Elliott
Wave International.
THE TECHNICAL ANALYST 39
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 Interview

Copyright UBS (2008)

Jason Perl is global head of

Fixed Income, Currencies and
INTERVIEW

Commodities Technical
Strategy at UBS Investment
Bank in London. He and his
team provide short and medi-
um term trading strategies and
bespoke educational training
sessions for clients. His area of
expertise for the past 14 years is
the DeMark suite of market
timing indicators and he is the
author of Bloomberg Market
Essentials: DeMark Indicators
(Bloomberg Press).

October 2008 THE TECHNICAL ANALYST 41

 Interview
TA: What was you motivation for writing your book on
DeMark indicators?
JP: I was approached early last year by David Keller (then
head of technical strategy at Bloomberg, now Director of
Technical Strategy at Fidelity in Boston). Bloomberg was
thinking of producing a series of definitive books based on
market timing and technical analysis techniques and David
asked if I would be interested in writing a user guide to the
DeMark indicators.
I suppose like many authors, I was adamant that it was
never my intention to put pen to paper, but over the years a
number of UBS clients around the world had asked for edu-
cational material covering the popular DeMark indicators, so
this was a great opportunity to address that demand. It was
also a chance to answer a number of questions that people
consistently ask about DeMark’s work when they start using
the indicators. Furthermore, very little information was avail-
able about TD D-Wave (developed by Tom DeMark as an
objective and mechanical version of Elliott Wave), which was
“THE TD SEQUENTIAL IS PROBABLY THE DEMARK
INDICATOR THAT PEOPLE ARE MOST FAMILIAR
WITH. ITS TOM’S SIGNATURE STUDY SO IT’S
GENERATED A LOT OF INTEREST IN THE 30 PLUS
YEARS SINCE IT WAS DEVELOPED”
generating a lot of interest and the book project gave me a
platform to discuss the subject in detail.
Hopefully the finished product accomplishes what we set
out to do, i.e. providing a definitive information source for
first time users, as well as a practical user guide for those
already familiar with the studies. Of course, I was delighted
when Tom DeMark offered to write the foreword and hon-
oured that a number of high profile industry names; John
Bollinger, Peter Borish, John Burbank, Leon Cooperman and
David Kyte endorsed the book.
TA:Which DeMark indicator do you use most often?
Are there some that you think are more effective
than others?
JP: Actually, rather than just one study, I use TD Sequential,
Tom’s signature trend exhaustion indicator in conjunction
with TD D-Wave. TD Sequential is good at identifying
prospective exhaustion points in both ranges and trends, but
42 THE TECHNICAL ANALYST October 2008
it doesn’t give you an insight into the magnitude of the
expected reversal. I find that when using TD Sequential on
multiple time frames, combining it with TD D-Wave puts the
signals into context – i.e. are we mid-way through the impul-
sive stage of a trend or in the latter part and therefore termi-
nal phase when a macro move is more likely? Typically, I find
that TD Sequential signals in TD D-Wave 3 (the impulsive
phase of a trend) are less reliable than TD Sequential signals
in TD D-Wave 5 (when the bulk of the trend has already hap-
pened).
As far as which indicators are more or less effective than
others, I think it’s more a question of what one’s investment
objective and time horizon is. Tom has both trending and
trend exhaustion indicators in his suite of tools so in my
opinion, it’s more a question of finding the DeMark indica-
tors that suit the individual’s objectives and personality – as
the old trading adage goes – your chosen methodology
should be defined by whether you wish to eat well or sleep
well. I don’t mean that flippantly: for example, counter-trend
trading is by definition counter-intuitive, so if you don’t like
going against the market consensus, then TD Sequential
probably isn’t for you.
TA: Does the Sequential Indicator remain the most pop-
ular DeMark indicator? If so, why do you think this is?
JP: Well, TD Sequential is probably the DeMark indicator
that people are most familiar with. Firstly, it’s Tom’s signature
study so it’s generated a lot of interest in the 30 plus years
since it was developed and along with its counterpart TD
Combo, it’s also the study that differs the most from whatev-
er else is available in the market.
TA: Have you done any back-testing of DeMark or do
you know of anyone who has? If so, what were the
results?
JP: Although I fully understand why new users would want
to back-test the DeMark indicators, I haven’t felt the need →

to do so personally because I’ve been using them real-time
for the past 14 years and have seen how they behave in all
types of environment. Suffice to say, while I recognise the
indicators are by no means infallible or indeed the Holy Grail,
I do believe they give one a considerable edge when it comes
to market timing if used in an objective and disciplined man-
ner over time.
A number of very smart people have tried to back-test the
indicators, but I should say that Tom is keen to emphasise
that his body of work is indicators, not trading systems. So
for TD Sequential, one does get an entry signal and an initial
risk level but DeMark doesn’t provide information on how to
manage the risk once the trade starts moving in your direc-
tion or advice on where to take profit. So if you did want to
back-test the TD Sequential, you’d need to recognise that the
results are based on your interpretation of how to manage
the risk and profit taking inputs.
TA: Presentations that we have heard on the Sequential
suggests that the profitability of trading Setups and
Countdowns lies not necessarily in the frequency of
their success but rather in using them as a risk manage-
ment tool. In effect, the gains from when the Sequential
works are much bigger than the losses from when it
fails. Do you go along with this?
JP: Yes, absolutely. Like I said, TD Sequential is by no means
the Holy Grail, but it does provide some acute risk / reward
trading opportunities, both in ranges and in the latter stages
of a trend. When used over multiple time frames and in con-
junction with other TD indicators such as TD D-Wave, the
hit rate on successful trades based on TD Sequential can be
significantly improved. Both Tom and I are keen to stress that
the indicators are market timing tools rather than technical
analysis per se. Increasingly I find non-technically oriented
customers are recognising the added value the indicators pro-
vide in terms of improving the efficiency of trade entry and
exit in conjunction with a fundamentally driven trade idea.
TA: What, in your view, are the main weaknesses of the
Sequential Indicator?
JP: By definition, since TD Sequential is counter-trend so it
will have a tough time when markets are trending strongly in
one direction. However, that’s precisely why I stress the need
to evaluate each signal on a case by case basis and consider it
in the context of the broader trend. One should always be
aware of what the indicator is saying on longer-term time
frames (so you know whether you are trading in-line with or
against the broader trend), and note where the signal lies rel-
ative to the current TD D-Wave count. That won’t complete-
ly offset the risk of being stopped out in strong trends,
but it will certainly reduce the occurrence in a very objective
manner.
TA: What are the main advantages of using the TD
October 2008
Interview
Combo versus just using the TD Sequential?
JP: Frankly, I always struggled to determine when one should
use TD Sequential rather than TD Combo and vice versa.
Obviously, it gives one a greater sense of confidence if the
TD Sequential and TD Combo happen to generate a signal
simultaneously, but since both indicators are trying to identi-
fy trend exhaustion points it can be difficult rationalising a
preference for one over the other.
However, a couple of things do stand out:
1) DeMark suggests TD Combo has a slight edge over TD
Sequential if one is trading off intra-day charts,
2) By definition, TD Sequential requires a minimum of 22
price bars before it can generate a buy or sell signal subse-
quent to a completed TD Setup and TD Countdown,
whereas TD Combo only needs a minimum of 13 price
bars to generate a completed TD Setup and TD
Countdown – so TD Combo is useful in determining
prospective trend exhaustion points after an abrupt direc-
tional move. Again, combining the indicators on multiple
time frames and coupling them with TD D-Wave gives
one an objective insight into the most opportune time to
use one rather than the other, particularly if the market has
reached a projected TD D-Wave target.
TA: What exit strategies do you use/recommend using
after entering a TD Sequential triggered trade?
JP: DeMark doesn’t discuss this in detail, so this is my per-
sonal interpretation;
1) Wait for a fresh signal in the opposite direction
2) Trade around prior TDST levels or
3) plot the distribution of signals generated by TD Sequential
over time and try to determine the most that the market
moves on average subsequent to a signal or prior to a pull-
back of at least x% - then use that as a take profit target,
regardless of whether there is a fresh signal in the oppo-
site direction or not.
TA: How has the use of DeMark changed over the past
few years? If it has increased, why do you think this is?
JP: When I first heard about the DeMark indicators 14 years
ago, their use was limited to a relatively small number of peo-
ple who were familiar with Tom and his work. The indicators
were not available on the mainstream quote vendors as they
are now (such as CQG, Thomson and Bloomberg). The
introduction of the TD indicators onto Bloomberg about 6
years ago was a tremendous boost as it meant the studies →
THE TECHNICAL ANALYST 43
 Interview
“UBS CLIENTS AROUND THE WORLD HAD
ASKED FOR EDUCATIONAL MATERIAL COVERING
THE POPULAR DEMARK INDICATORS, SO
[THE BOOK] WAS A GREAT OPPORTUNITY TO
ADDRESS THAT DEMAND.”
became readily available to a much wider audience and could
be applied to a much bigger universe of instruments. Since
then, Bloomberg, Tom DeMark and the team of people
working with Tom (including TJ Demark, Rick Knox and
Roderick Bentley), have done a fantastic job of enhancing the
TD indicator functionality and user experience.
In the past 18 months, Market Studies (Tom’s company), in
association with Bloomberg introduced the TDRS service. A
number of features have significantly enhanced the value of
the indicators in my opinion and as people are getting a bet-
ter appreciation for how they work, they’re realising the
power of the studies. Specifically, there is an educational
service called TD Cursor Commentary, whereby the user
clicks on an individual price bar to see the interpretation of
the TD studies applied to that bar. There is also an instant
messaging service on Bloomberg, where Tom and his col-
leagues provide real-time educational information about the
application of the indicators. Lastly, and perhaps most valu-
able is a scanning facility. This enables users to scan virtually
the entire Bloomberg database for TD based signals on mul-
tiple time frames. One can even create custom portfolios and
look for signals based on combinations of TD indicators. I
believe this functionality is revolutionary and opens up a
whole new area of relative value trading opportunities which
would not have been possible previously.
TA: Is your TA research mainly focused on using
DeMark?
JP: I believe UBS Technical Strategy is unique in the sense
that the group consists of product specialists, (based in
London, Zurich, Stamford and Singapore), who are each
experts in their respective areas. Consequently, each member
of the group publishes research (and trade ideas) based sole-
ly on their individual methodology. My personal focus is
DeMark and the majority of the research that I produce is
based on that in addition to some historical statistical analy-
sis. That’s not to say I don’t believe in other forms of analy-
sis, quite the contrary – but I do believe there is a limit to the
number of things one can follow and this particular method-
44 THE TECHNICAL ANALYST October 2008
ology happens to appeal to me and my trading psyche.
TA: To what extent is DeMark used by UBS
traders/investment managers and your clients?
JP: I cannot comment on this question specifically for client
confidentiality reasons, but the number of people who look
at or use the indicators has grown over time. Personally, I am
most encouraged by the number of fundamentally oriented
traders who are starting to incorporate the TD indicators into
their analysis to improve the efficiency of their market timing
– something that was far less prevalent amongst traders 9
years ago before I joined UBS.
TA: To what extent is DeMark used in the markets?
Bloomberg say that they have around 36,000 users of
DeMark on their terminals. Does this sound accurate?
JP: I couldn’t comment on exact numbers, but given the fact
that Bloomberg have roughly 350,000 customers, it’s not
unreasonable to assume that roughly 10% of those look at
the TD indicators in some form or another.
TA:: Did any DeMark indicators signal the current crisis
in the credit markets/banking stocks?
JP: One of the advantages of TDRS and the scanning func-
tionality is that it enables one to follow a large number of
instruments and look for common macro themes among the
signals generated. I don’t have a stock specific remit as my
primary focus is FX, fixed income and commodities, but it
was interesting to me that there was a confluence of cross-
market signals in a number of markets over the summer: a
buy signal on the VIX at 16.30 on 15-May, a sell signal in US
2 Year yields at 2.9206% on 10-June: a sell signal at 108.18 in
USDJPY on 13-June, a sell signal in the Nikkei at 14,354 on
16-June: a sell signal in the Nasdaq Composite at 2,457.7 on
17-June, a buy signal in gold at 883.80 on 23-June and a sell
signal in AUDCHF at 1.0011 on 27-July.
 Research Update

EXPLOITING FRACTALS
Moving averages and trading range break-
out rules are the best at exploiting long-
term dependencies in financial data,
according to Camillo Lento of Lakehead
University. His results, based on analyzing
Dow Jones Industrial Average data, sug-
gest that the fractal nature of a time series
leads to dependencies that technical
analysis should be able to identify and
exploit to earn profits. Lento’s research
showed that moving averages and trading
range break-out rules were the best at
exploiting these dependencies.
Lento, Camillo,A Synthesis of Technical
Analysis and Fractal Geometry - Evidence from
the Dow Jones Industrial Average Components
(September 4, 2008).

FX Strategy: Fundamentals and Technicals

Combining fundamental and technical
analysis into one strategy brings
improved risk-adjusted returns, according
to four Netherlands-based researchers. In
their study, they measure the economic
value of information derived from
macroeconomic variables and from tech-
nical trading rules for emerging markets
currencies, based on a sample of 21
emerging markets with a floating
exchange rate regime over the period
1997-2007, using non-deliverable forward
data. Specifically, they assess the per-
formance of currency trading strategies
based on monthly real interest rate differ-
entials and GDP growth as well as mov-
ing average trading rules and support and
resistance levels. They document that
both types of information can be exploit-
ed to implement profitable trading strate-
gies. In line with evidence from surveys
of foreign exchange professionals con-
cerning the use of fundamental and tech-
nical analysis, they find that combining
the two types of information improves
the risk-adjusted performance of the
investment strategies. The authors also
speculate that a dynamic weighting
scheme between technical and funda-
mental information may yield improved
performance relative to an equally
weighted combination.
De Zwart, Gerben J., Markwat, Thijs D.,
Swinkels, Laurens A.P. and Van Dijk, Dick J.
C.,The Economic Value of Fundamental and
Technical Information in Emerging Currency
Markets(21 2007, 12). ERIM Report Series
Reference No. ERS-2007-096-F&A

Deflated Optimism? CATEGORIZING INVESTOR

BEHAVIOUR
Long-run stock market underperformance after security offerings is a
well documented phenomenon and some have conjectured that this
post-issue underperformance might be the result of pre-issue investor
optimism. Researchers from California State University have investigat-
ed this by looking at: 1) whether investor optimism is associated with
post-issue underperformance; 2) how investor optimism changes in the
one-year period surrounding the security-offering month; 3) whether
investor optimism differs between equity issuers and debt issuers; and
4) whether such differences affect companies' financing choices. Their
findings confirm underperformance of debt and equity issuers and
found that the post-issue buy-and-hold abnormal returns are negative-
ly associated with pre-issue investor optimism. They found little evi-
dence, however, that investor optimism affects companies' financing
choices.
Yi, Bingsheng, El-Badawi, Mohamed and Lin, J. Barry,Pre-Issue Investor
Optimism and Post-Issue Underperformance(September, 23 2008). Financial
Analysts Journal, Vol. 64, No. 5, 2008
Making the link between behavioural biases at the
individual level and what we see in the markets
remains largely a matter of untested speculation. A
team of researchers from Erasmus University in the
Netherlands has looked at how models can be used
to build stylized representations of individual
investors and further studied using agent-based arti-
ficial financial markets. In this way, agent-based mod-
els can bridge the gap between the micro level of
individual investor behavior and the macro level of
aggregate market phenomena, and can be used as a
tool to generate or test various behavioural hypothe-
sis.
In the same vein, Indian investors have recently
been categorized into different personality types and
researchers have explored the relationship between
various demographic factors and investment person-

MOMENTUM VERSUS REVERSAL

Two UK-based researchers have provided evidence from US, UK and
Japanese equity markets that returns depend on the size and sign of
previous price changes. They find support for the idea that investors
display behavioral biases and simultaneously underreact to some types
of events and overreact to others. Their results show that the market
tends to reverse after large price changes, while after small price
changes a momentum type effect is observed.
Hudson, Robert and Atanasova, Christina V.,Short Term Overreaction,
Underreaction and Momentum in Equity Markets(July 10, 2008).
ality. Their results reveal that the Indian investor can
be classified into four dominant investment person-
alities – casual, technical, informed and cautious.
Lovric, Milan, Kaymak, U. and Spronk, J.,A Conceptual Model
of Investor Behavior(June 23, 2008). Erasmus Research Institute
of Management - ERIM, Forthcoming. Mittal, Manish and
Vyas, R. K.,Personality Type and Investment Choice: An
Empirical Study(September 4, 2008). The Icfai University
Journal of Behavioral Finance, Vol. V, No. 3, pp. 6-22,
September 2008

October 2008 THE TECHNICAL ANALYST 45

 Research Update

Volume Spikes
Further evidence that past price extremes
influence investors' trading decisions has
emerged from a US-based research team.
They show that volume is strikingly high-
er when the stock price crosses either the
upper or lower limit of its past trading
range. This increase in volume is more
stock price last achieved the price
extreme, the smaller the firm, the higher
the individual investor interest in the
stock, and the greater the ambiguity
regarding valuation. Volume spikes when
price crosses either the upper or lower
limit of the past trading range, then grad-
are reliably positive and, among small
investors, trades classified as buyer-initi-
ated are elevated.
Huddart, Steven J., Lang, Mark H. and
Yetman, Michelle,Volume and Price Patterns
Around a Stock's 52-Week Highs and Lows:

New Momentum
pronounced the longer the time since the ually subsides. After either event, returns Theory and Evidence. Management Science.

Earnings
Surprises and
Market
Richard Harris of the University of low frequency momentum trading strate-
Exeter and Fatih Yilmaz of Bank of gy offers greater directional accuracy,
America have developed a momentum higher returns and Sharpe ratios and

Sentiment
There is growing evidence in the finance
literature that investor sentiment affects
stock prices. Two researchers from New
York University have examined whether
stock price reactions to earnings surprises
trading strategy based on the low fre-
quency trend component of the spot
exchange rate. Using, alternately, kernel
regression and the high-pass filter of
Hodrick and Prescott (1997), they recov-
er the non-linear trend in the monthly
exchange rate and use short-term
momentum in this to generate buy and
sell signals. According to the authors, the
lower maximum drawdown than tradi-
tional moving average rules.
Harris, Richard D. F. and Yilmaz, Fatih,A
Momentum Trading Strategy Based on the Low
Frequency. Component of the Exchange
Rate(August 2008). Xfi Centre For Financial
& Investment Working Paper No. 08/04.

INTRA-MONTHLY MOMENTUM
and accruals vary systematically with the
level of investor sentiment. They find

evidence that holding extreme good news
firms following pessimistic sentiment
periods earns significantly higher excess
returns than holding extreme good news
firms following optimistic sentiment peri-
ods. Similarly, their results suggest that
holding low accrual firms following pes-
simistic sentiment periods earns signifi-
cantly higher excess returns than holding
low accrual firms following optimistic
sentiment periods. In addition, they doc-
ument that excess returns in the short
window around the preliminary earnings
announcements for extreme good news
firms are significantly higher during peri-
ods of low sentiment than during periods
of high sentiment. Overall, their results
indicate that investor sentiment influ-
ences the source of excess returns from
earnings-based trading strategies.
PATTERNS
Are momentum strategies in the FX markets likely to work consistently through the
month? Not according to a team from the Universities of Exeter and Bristol. In their
paper, they document a very strong day-of-the-month effect in the performance of
momentum strategies in the foreign exchange market. For example, for simple mov-
ing average based strategies the authors found that the Sharpe ratio is close to zero
during the first half of the month until day 12, from when it starts to rise sharply,
peaking initially around days 13-15, and then again at around days 20-22. The authors
show that a two-factor model employing conditional volatility and the volatility of
conditional volatility explains as much as 70 percent of the intra-month variation in
the Sharpe ratio. They further show that the seasonality in volatility is in turn closely
linked to the pattern of US macroeconomic news announcements, which tend to be
clustered around certain days of the month.
Harris, Richard D. F., Stoja, Evarist and Yilmaz, Fatih,Day-of-the-Month Effects in the
Performance of Momentum Trading Strategies in the Foreign Exchange Market(October 2008).
Xfi Working Paper No. 08-05.

Livnat, Joshua and Petrovits, Christine,Investor

Sentiment, Post-Earnings Announcement Drift, All papers are available from the Social Science Research
and Accruals*(September 1, 2008).
Network, SSRN, www.ssrn.com

46 THE TECHNICAL ANALYST October 2008

 Book Review

DEMARK
INDICATORS
Jason Perl is head of technical analysis at UBS in London, and is well known as one of the
financial market’s acknowledged experts on the indicators of Tom DeMark. DeMark himself
works closely with Steven Cohen at SAC Capital in the US, one of the world’s largest hedge
funds. This fact alone lends credence to his work and should persuade those who are highly
sceptical of his indicators to spend some time looking more closely at them.
Tom DeMark is always keen to stress that his indicators are more a market timing technique
rather than pure technical analysis. Either way, while DeMark does have many loyal followers,
evidence suggests that the indicators are still of minority interest among the trading and invest-
ment community. However, their profile has increased in recent years and this book meets the
demand for those wishing to learn more.
DeMark indicators are potentially a difficult technique to describe in writing. While they are
not especially complex to understand, they are more mathematical in nature than many tech-
nical indicators and as such, are better understood by looking at real examples. Because of this,
it is important that any book on the subject is clearly written.
By Jason Perl
Much of Perl’s book focuses on the TD Sequential indicator, the most popular and widely
Published by
Bloomberg Press used of all the DeMark range. This is a counter-trend signal generator that looks to capture
208 pages points of market exhaustion and reversal – both in uptrends and downtrends. Its popularity is
ISBN: 978-1-57660-314-7 probably down to the clarity of the signals it generates and the lack of active price analysis
$29.95 required by the user: the software generates the buy and sell signals – the so called Setup 9s
and Coundown 13s - and sets the stops. All the trader needs to do is determine his exit.
Perl describes in easy to follow detail how the Setup and Countdown work along with trad-
ing tips and numerous examples. He also augments each chapter with a FAQ section that
addresses some of the points that are often brought up about the indicators. These include,
for example, why the parameters 9 and 13 are used in the TD Sequential. While his answers to
some of these points, including the backtesting of the indicators, may not satisfy everybody,
he makes no attempt to shirk some of the more difficult questions usually posed about the
indicators.
However, there is a lot more to DeMark than the TD Sequential. Tom DeMark has his own
interpretation for many traditional technical analysis techniques such as moving averages and
trendlines. These are well worth further investigation as they offer a new approach to tradition-
al techniques that often suffer from subjectivity in their application. Perl also covers the TD
Combo, the TD D-Wave, TD Lines, TD Retracements, Trends, Oscillators and Waldos.
Tom DeMark’s own book on his indicators, “New Market Timing Techniques”, published in
1997, has been criticised by some as difficult to read and understand. If this is the case then
Perl’s book is a well written and essential antidote to this. In addition, Bloomberg’s new range
of technical analysis books are well designed and crucially, appear to have benefited from care-
ful editing, something that many such books often lack. If you are looking for DeMark enlight-
enment, or simply a fresh way to analyse price action, then this is the book to get.

A ll of the above books are available from the Global Investor bookshop at a discount. Please call +44
(0)1730 233870 and quote "The Technical A nalyst magazine".

October 2008 THE TECHNICAL ANALYST 47

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