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15

Figure 3.6 a trending market with a nontrending indicator. By using 50 as a buy level, the stochastic gives accurate signals in the direction of the trend.

INDU 07/28/95

Dow Jones Industrials (Daily)

4352

.ltnn,,trtntintl,,,tHtt

\mr-mli>Mwtllii(Wtiiifr

m-i-n-n-i-i- -i-i-rn-i-mi-i-i-i- i i-i-m-i-I-m-i-i-i-rr ND95FM A M J J

Stochastic

Source: AIQs TradingExpert. Used by permission.

which happened in early March, twice in May, and again in July (see arrows on the price chart in Figure 3.6).

Nontrending Security-Improving the Odds

Almost every security is in a trend, but sometimes it is necessary to look at more data to find what the trend is. Plotting only the last few months may show that no trend is in place while a two-year chart may reveal that the security is in a definite uptrend. A good example of this is Mirage Resorts at the end of 1995. Figure 3.7 shows a chart of Mirage Resorts (MIR) using daily data. We see a nontrending security as the stock crosses its 28-day moving average often.

By plotting the same stock using weekly data, we get a different picture (Figure 3.8). The stock began a strong rally in early 1995 as it rarely crossed below its 28-week moving average. Whereas the daily chart shows a stock in a trading range, its weekly chart reveals an uptrending stock that is currently undergoing temporary consolidation.

Once the long-term trend is determined, we can improve our odds by trading only in the direction of the long-term trend. On the daily chart, the stock is consolidating so



Figure 3.7 A nontrending stock as it frequently crosses its

28 day moving average often.

Mirage Resort Inc (Daily)

MIR 12/29/95 [13 - 72)

i-1-i-1-1- - -i-1-1-n-1-1-I-1

SO N D

-fj-

Source: AIQs TradingExpert. Used by permission.

Figure 3.8 Determining the trend. Using weekly data, we see Mirage Resort is in an overall uptrend.

Mirage Resort Inc (Weekly)

MIR 12/29/95 [A3 21)

-i-I-I-I-I-i-1-I-I-I-I-I-I-I-I-I-I-I-I-I- A MJJ AS OND95FM AMJ JAS N D Stochastic

Tff 80 40 0

-------------

Source: AIQs TradingExpert. Used by permission.



the stochastic or an RSI indicator is appropriate. Since the overall trend is up, we can improve the accuracy of the signals by acting only on the buy signals.

Performing the same type of analysis on MIRs weekly chart also shows that we should be concentrating on the long side. Using weekly data (Figure 3.8), we see the stock is trending higher over the long term. For an uptrending stock, we know to ignore sell signals from indicators that work best in trading markets. However, by making adjustments to the oversold levels of these indicators, we see that MIRs stochastic gave two oversold buy signals in the fourth quarter of 1995 as its value fell below and then rose above the 50 level.

Conclusion

Indicators can be classified into two categories: those that work in trending markets and those that work in nontrending markets. Unless adjustments are made to an indicators interpretation, you can get into trouble when you apply the wrong type of indicator in a given market environment.

An indicator that works well in a trading market will constantly give signals opposite the trend for a strong trending security. When a security is in a nice uptrend, ignore overbought sell signals. Conversely, if you apply an indicator that works well in trending situations to a nontrending security, you will trade often but will end up selling at about the same level as the purchase price.

It is best to apply nontrending type indicators to securities that are in a trading range and to apply trending type indicators to securities that are in a trend. When using nontrending type indicators, it is always best to follow the signals that are in the direction of the securitys long-term trend.



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