Compute Your Way to Increased Pmfits

FFGURE -

II HALF-SPAN/

MOVING AVERAGE-

21.7 WK. CYCLE - LCWS

INVERSE. HALF-SPAN MCVING AVERAGE

\2..1 WK. OrCLE -UDWS -

r+4 +3 +2 +1

0 -I -2 -3 L-4

The Inverse HaIf.>Span Average

over the entire time period covered by illustrations VI-1 through VI-7. This time, instead of using a ten-week average, an 11-week one is shown. With the number of elements of the average being "odd," each average datum directly corresponds (in time) to a weekly price datum instead of falling in midweek (as for the ten-week one). In this way subtraction can be accomplished dim;tly without need for interpolation. As formed, each moving average is subtracted from the corresponding mean weekly price of the stock.

The results could be plotted as points about a "zero" base line, either by themselves or connected by straight lines. However, the process of erecting vertical lines from zero to the value of the difference (as in Figure VI-8) seems to provide the eye with more information.

What can we make of this plot?

First of all, the dominant cychc component just shorter m duration than the trading cycle is now clearly evident. Counting weeks (low-to-low and high-to-high) and averaging gives a nominal duration of 12.7 weeks, with a "spread" from ten to 16. The correlation with an expected component of the price-motion model is obvious.

Secondly, it is seen that the magnitude of this cycle averages seven points peak-to-peak (±3 1/2 points). It is seen that the inverse average provides cycle magnitude ductly, without necessity for, and without the error inherent in, the construction of envelopes!

Thirdly, we note that a simple process of subtraction converts a half-span average (which is vitally useful on its own) into that specific inverse average which is most capable of identifying the component of duration just less than that of the trading cycle. As seen in previous chapters, identification of this component is an essential part of the process of setting up trailing loss levels and seD signals in general. And, you will normally have aheady computed the half-span average anyway!

Now. How does all this aid transaction timing?

Return to Figure VI-6 and VI-7. In the discussions regarding these figures it is noted that the half-span average had put us in the stock short at 51 to 52. But, prices seemed to refuse to go down-oscillating instead from 44 to 51 for nine weeks. The half-span analysis assured us the stock was headed for 40 5/8. Does the inverse half-span confirm this conclusion?

In Figure VI-8, the inverse half-span average is two weeks away from a low of the 12.7-week cycle. The stock price is an additional five weeks along (due to the lag of the average). So, were now seven weeks along on a component (next shorter in duration than the trading cycle) which averages 12.7 weeks, and varies from ten to 16 weeks. We expect the next significant low of this cycle in a time zone three to nine weeks from now.

In addition, the 21.7-week (average) duration trading cycle (which varies from 20 to 23 weeks in length) is now 19 weeks along from a low. We expect the next significant low of this cycle in a time zone one to four weeks from now. With both of these important cycles due to low out in the same general time period, we know the stock still has more to go on the downside. In fact, taking 6/13 of 7 points, we expect about 3.7 points more on the downside from the 12.7-week cycle alone. An additional

3/22 of 14 or 1.9 points remains in the 21.7-week cycle. The present price is 45 which, less 4.6, leaves 40 1/2 as a low-out estimate.

We conclude that the stock will reach approximately 40 1/2 within one to nine weeks. This estimate compares almost identically with that obtained using the half-span average alone (40 5/8 in three weeks)-yet was obtained using information the half-span average "threw away "I

With this additional reassurance, we do not hesitate to remain in our short position-and the stock proceeded to bottom out at 41 the next week, nicely within our tolerance zone!

TRY THE INVERSE AVERAGE IN OTHER WAYS

An inverse moving average can be formed from an average of any span. Any time you wish to inspect a given component more acciurately, simply form an average of span equal to the component duration. The associated inverse average must show the desired fluctuation at exactly the correct magnitude, since it is present in price to this extent but is precisely zero in the moving average. Taking the difference between the two displays this particular fluctuation on a zero baseline in all its glory!

This usage is particularly important as you are approaching buy and sell points. Extract the higher frequency components in this way, and you will never have to guess about trend line validity and channel turn-around.

Another excellent application: extract your trading cycle in this manner before you act on buy signals. The state of the magnitude-duration fluctuation situation is clearly discernible once the large, long components are removed. You may save yourself from acting on a perfectly valid buy signal only to find your trading cycle has shrunk to near zero in size!

Try the inverse average at triangle resolution points. Once again, the mechanics of formation of these patterns via magnitude-duration fluctuation of short duration components will be made very clear. In addition, the short duration component information derived will aid greatly in pinpointing pattern resolution times.

TO SUMMARIZE

• Half- and full-span moving averages can be used to predict the extent of price fluctuations.

• Envelope analysis is used to identify and establish the average duration of a trading cycle.

• Two moving averages are then constructed. One has a span equal to the average duration of the tradmg cycle. The other has a span equal to one-half the duration of the trading cycle.

• These are plotted on the same chart as the stock, with due consideration for the time lag of each.

• When the half-span average reverses direction, important move prediction information is made available.