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When playing the short side near market tops, I dont recommend shorting strong relative strength stocks, because if you are wrong, then you will lose more money. Nor do I recommend shorting the weakest stocks, because they often dont have far to move on the downside. I prefer to short the mid-range relative strength stocks because if you are wrong, you dont get hurt too badly, and if you are right, you can still make some hefty profits.

The time to short the strong stocks is after an intermediate -term or long-term top has occurred in both the Industrials and the Transports, and you get a confirmed change of trend in the stock by the 1-2-3 criterion. This kind of action is ideal for picking up some quick profits in the short term, because if the market continues to sell off after you get a confirmed top in a strong stock, the stocks price is liable to fall precipitously for one to three days in what is effectively a panic movement. It is best to take profits quickly on this kind of trade, however, because there will be p lenty of buyers looking for a bargain in the stock because of its previous strength, and the price is apt to recover quickly.

While relative strength is an important secondary indicator, I place it lower on the scale of importance than moving averages. In other words, if the stock price is below the moving average and the relative strength is good, I weight the moving average more heavily and pass the stock up as a potential buy.

The concept of relative strength is applicable in the commodities markets as well, but the way you apply it is slightly different. If you are considering a long position in the precious metals, for instance, you would compare the relative strength of gold, silver, platinum, etc., to one another and buy the strongest of the group. For example. Figure 8.8 shows the weekly bar charts of gold and silver. A quick look shows two things: first, silver made new lows in September and gold never did, and second, gold broke its previous June intermediate high, but silver failed to break its previous March intermediate high. Obviously, gold has greater strength than silver-its relative strength is greater.

Daily Bar Chart


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Figure 8.8 December 1990 Gold (top) and December 1990 Silver (bottom) futures -relative strength comparison. A quick look shows that while gold was making new intermediate highs, silver failed to. Also, while silver made new lows in September, gold did not. Gold has greater relative strength than silver.

You can also use relative strength in the commodities to determine how to position yourself in a hedge or a spread. When looking at the grains, for example, compare the relative strength of com to wheat. A quick glance at the daily bar charts of both shows that com is stronger than wheat (Figure 8.9), so the best play is to go long com and short wheat. That decision is confirmed by a plot of the daily price differential of com to wheat (Figure 8.10). MOMENTUM INDICATORS (OSCILLATORS)

Moving objects have a property called momentum, which is what you might call the quantity of motion of an object. The actual measurement of momentum is the product of somethings mass times its velocity. A swinging pendulum, for example, has constantly changing momentum, which if plotted against time, would look something like Figure 8.11.

Although not in the strict physical sense, markets also have momentum. You can think of the plot of the pendulums momentum as idealized market behavior, where prices osc illate around a steady center point, where the velocity of price

Daily Bar Chart




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Figure 8.9 December 1990 Com (top) and December 1990 Wheat (bottom) Futures-relative strength comparison. If you realize that prices are in /,o of a cent per bushel (i.e., 2400 equals $2.40 per bushel) a quick glance indicates that, while both com and wheat are in downtrends, com is out -performing wheat-it has greater relative strength.

changes is constantly changing and the reverses at the top and bottom of the plot corresponding to market tops and bottoms.

But unlike a pendulum, which has a constant mass and changing velocity, market momentum has both constantly changing mass (changing trading volume) and constantly changing velocity (fluctuating rates of change of prices). In addition, there are forces which influence the market, such as breaking major political or economic news, that can radically shift market momentum at any time.

Consequently, it is impossible to measure market momentum with complete accuracy and use the measurement to predict market turning points with certainty. It is possible, however, to develop correlations that closely approximate market momentum and help predict when the price trend is changing. The best of these indicators are called oscillators.

To the best of my knowledge, the term oscillators, which is now a standard industry term, was initially used by H. M. Gartley in his book. Profits in the Stock Market, first published in 1935. Like moving averages and relative strength indexes, oscillators come in a variety of formulations, but the element common to them all is that they measure the differences in some market parameter over some specific period of time. They are, therefore, measurements of the rate of change

daily spread

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tq 20/20 1991 cqg inc ~

Figure 8.10 A plot of the December 1 corn-wheat daily spread. As

indicated by the relative strength comparison, a good hedge play in the grains would have been to go long corn and short wheat.

(-} . 1\ Momentum

Figure 8.11 Plot of the momentum of a F>enduium versus time. The plot of the momentum of a pendulum versus time oscillates around the baseline. You will notice the similarity of this pattern to that of momentum oscillators used in analyzing market behavior.

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