Weekly Bar Chart

Week Moving Average II

Week Moving Average

Buy Spot

lUL CXTT

JAN APR JUL OCT JAN APR 1989 1990

TQ 20/20 1991 CQC Inc.

Figure 8.5 The Gold Futures weekly bar chart - a buy spot given by the 10-week/30-week cross rule. When the 10-week moving average crosses the 30-week moving average and the trend of both is up, this comprises a buy signal.

Weekly Bar Chart

2000 -

180O

1600

1400

Sell Spot

30 Week Movir

Week Moving Average

E3uy Spot

JUL OCT

JAN APR 1990

JUL OCT

JAN APR 1989

TQ 20/20 «1991 CQG Inc.

Figure 8-6 The British Pound Futures weekly bar chart - a sell spot given by the 10 week/30 week cross rule. When the 10-week moving average crosses the 30-week moving average and the slopes are both down, this comprises a sell spot. Note that you get both a sell and later a buy on this chart.

2. When the 10-week moving average crosses the 30-week moving average and the slope of both averages is down, this comprises a sell signal, provided prices are below both moving average lines (see Figure 8.6).

Of course, as with all technical observations, these observations are never right 100% of the time. For example, you would have been creamed on October 19.1987 if you used only the 10 -weeV30-week cross rule. By the time you got the sell signal, the crash was over.

For the commodity futures markets, there is no hard and fast rule about which long-term moving average works best it varies from market to market and over time. For example, at this writing, the 200-day works well for bonds, the dollar index, an d gold but not so well for the other commodities.

Basically, youve got to recognize that, as a technical tool, the validity of the moving averages is apt to change with changing market conditions. The shorter the term that you trade in, the more this is true. So, you have to experiment with different times and find the ones that work. When they quit working, youve got to change again. For example, on pork bellies, Ive been using the 4-week and 11-week moving averages and I apply a rule similar to the 10-weeV30-week rule I described above. Just recently, however, the relationship has started to get sloppy, so it might be time to experiment with the time periods again.

The biggest mistake anyone can make in using moving averages, or any technical observation for that matter, is to fall in love with it. By that I mean dont ever think you have found "the rule to end all rules"; no such thing exists. Every market is in a constant process of change, and any method which doesnt take change into account in a fundamental way is subject to being wrong.

In philosophy, I strongly disagree with the school of Pragmatism, - but when it comes to trading rules, you have to be completely pragmatic. A rule is right only as long as it works. When it quits working, youve got to kiss it goodbye and leave it alone. Otherwise, just like a bad relationship with a person, it will bring you down. Ive seen it happen to people who were at one time considered to be among the best traders on Wall Street. So be careful not to get emotionally involved with any discovery you make when identifying patterns using the moving averages or any technical method.

A DIFFERENT PERSPECTIVE ON RELATIVE STRENGTH

To the best of my knowledge, the concept of relative strength was first discussed by Robert Rhea in a Baryons article in 1933. He didnt call it relative strength but rather the "habits of stocks and how they perform against one another." Relative strength is simply a ratio between a single stock against a stock group or an average index, or between a stock group and a larger group or average index.

Like moving averages, there are all kinds of different formulations of relative strength. Some chart books, for example, weight recent weeks more heavily than others. For example, in New York Stock Exchange Daily Graphs, each stock has

a relative strength line which is a plot of the ratio of the stock price to the S&P 500 Index on a weekly basis, plus there is another time-weighted relative strength indicator which compares the percentage change of the stocks price to the change in price of stocks in the database (see Figure 8.7). The number varies from 1 to 99. The number 52, for example, would indicate that the stock outperformed 52% of all other stocks in the database."

The idea of relative strength is sometimes difficult to understand because we are brought up with a consumer mentality. As kids, we watch our parents look for sales, and most of us carry on that tradition; we all try to buy cheap and sell dear.

For example, assuming that you like citrus fruit, if you went to the grocery store and saw that both oranges and grapefruit were selling at fifty cents per pound, you would probably buy a few of each. But if you went back a week later and found grapefruit suddenly at a dollar per pound and oranges still at fifty cents, you would probably opt just to buy oranges and wait for a better market in grapefruit. If you use this same kind of thinking in buying stocks, you are often making a big mistake.

You should never buy a stock simply because its cheap; the chances are that it is probably cheap for a good reason. What you want is a stock that is going to

TRW Incorporated (TRW) Diversified Operations

OCT 1990

Data for chart courtesy. Daily Graphs

Figure 8.7 Relative Strength indicator as used in the New York Stock Exchange Daily Graphs. In this example, the line shows the relative strength of the individual stock versus the S&P 500. The number 52 is the relative strength value, indicating that it outperformed 52% of the stocks in the data base.

perform, that is going to appreciate in value faster than the average stock. Relative strength is a measure of this kind of performance. All things bein g equal, if you are looking to buy a stock, you should buy the strongest performers, as indicated by the best measurement of relative strength available.

So far, Ive discussed how relative strength is typically used. There is another way of looking at relative strength that relates directly to my definition of a trend. Recall that when the market is in an uptrend, it makes a series of higher lows and higher highs. So, what I do is look at the Industrials average, and if it has made a higher high, then I lo ok for stocks that have made a higher high on the same day as, or on days before the average.

These are the strongest stocks-the market leaders. If the market is in an uptrend, then these are the stocks that, everything else being equal, you would want to buy, but not when they make the higher highs. You buy them on reactions, during sell-offs, because the chances for fast retums are better. Strong relative strength stocks move more quickly on the upside than the other stocks in the market.