Market Technician No 46

Last Octobers IFTA conference was heralded as a great success. For thoseof you who were not able to attend, transcripts of some of thepresentations are included in this issue. Next year the IFTA conference willbe hosted by the MTA and will take place in Washington. More details willbe given later.

We would like to take this opportunity of thanking David Charters and ElliGifford for donating a number of their books on technical analysis to thelibrary. The Societys postal library service provides an invaluable serviceto members all over the country and donations of books are alwayswelcome but they do need to be in good condition.

A number of changes have been made to the Societys website(www.sta-uk.org) in order to allow us to offer new services andinformation to members. The website is viewed by the STA board as avery useful means of fulfilling our mission, namely to promote greater useand understanding of technical analysis as a vital investment tool.

The changes that we have implemented over the last year and a half werebasically to make sure that we put up relevant information on the websiteas soon as possible and to make sure that what was on the website wasinformative, useful and easy to find. One note of success was that weactually used the website to accept bookings and payments for the IFTAconference last year, as well as having all of the documentation for theconference up on the web well ahead of the snail mail deliveries.

The home page is our face to the world and we try to make sure that anyrelevant changes to the site, meetings, education courses and events areflagged here in the first instance. By visiting our home page membersand non-members see the STAs mission statement, logo, links to articlesdescribing what technical analysis is all about and the latest informationabout events, courses and meetings in bullet points. Access to the mainprogrammes of the STA is provided by having a permanent index on ourhome page directing the user to our Education, Meetings, ReferenceSource, Journal, Membership, Committee, Useful Links, Recruitment andCharts sections.

In the public area of the website we will be introducing a FrequentlyAsked Questions (FAQ) section, where payment information, courseinformation, location and timing of courses will be made even clearer.While all of this information is on the web in one form or another, thereare a number of routine questions that could probably be listed in theFAQ section to make life simpler for students and prospective students.We are always trying to put information onto the web regarding speakers,special events, changes to any schedules etc. as soon as it is available but,judging from the emails that are received on this, the more forwardlooking that we can be, the better!

The main changes over the coming year should be in the long awaitedmembers only section. The purpose of our members only section is topromote greater use of our archived material, allow members to post theirdetails for contact on certain markets or issues if they so desire and toprovide some of the monthly meeting speaker notes and slides after themeetings. For students enrolling on a STA course there will be moreinformation on the coursework together with notes and some practiceexams. We also plan on putting some store fronts in this section such aslinks to online booksellers etc. We will be working with some of therecruitment firms to post positions in the members only section whenappropriate and will be putting up a notice board for members interestedin new employment opportunities. These are just the first steps in thissection and as members use it and come up with their own ideas thewebsite will continue to evolve. If you have any ideas or suggestionsplease contact Gerry Celaya who chairs the website committee.

IN THIS ISSUE

G. Celaya IFTA walk about . . . . . . . . . . . . . . . . . . 2

Obituaries . . . . . . . . . . . . . . . . . . . . . . . 3

I. Stannard & Optimising entry levels for P. Wilkinson maximum risk control . . . . . . . . . . . . 4

H. Okamoto Asset allocation in Japanese andUS stock markets by means oftechnical analysis . . . . . . . . . . . . . . . . . 7

N. Elliott Option strategies using IchimokuKinko clouds . . . . . . . . . . . . . . . . . . . . 11

P. Beuttell Still a Great Bear Market . . . . . . . . . 15

R. Acampora &E. Keon The pattern of war . . . . . . . . . . . . . . 16

March 2003 The Journal of the STAIssue No. 46 www.sta-uk.org

MARKET TECHNICIAN

COPY DEADLINE FOR THE NEXT ISSUE

31st May 2003

PUBLICATION OF THE NEXT ISSUE

July 2003

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MARKET TECHNICIAN Issue 46 March 20032

I had the pleasure of helping with the famous Walk About session at theIFTA conference in October and hosting one of the Software discussiontables. This session helps the delegates to get to know each other as theydiscuss various topics in an informal setting. Ian Notleys experience inrunning these sessions ensures that all delegates meet exactly half of thetotal number of delegates. It is interesting to discuss different techniquesand tools and, in the case of the table that I was chairing, software, withdelegates from every corner of the world.

Almost all of the delegates used technical analysis as a professionalinvestment tool and most also used the techniques in their privateinvestment decisions as well. (I was surprised that all of the delegates didnot use technical analysis in their personal investments.) The software ortrading station that was most frequently cited was Bloomberg, followedby Reuters, Metastock, Tradestation, CQG, Updata, Insight Trader andTC2000.

The choice of software could, in most cases, have a lot to do with thenature of the delegates job. It seems that many of the delegates thatcame through my table were employed as equity analysts, portfoliomanagers (equity) or equity traders. The software package on their desksseemed to be Bloomberg or Reuters, as the combination of somegraphics/technical tools and a robust data feed was difficult to match. Forchart scanning/screening and systems testing it seemed that Metastockand Tradestation were still widely used. The futures market delegatescited CQG as their main tool, while the UK delegates mentioned Updata asa stock charting software of choice. Australians and US delegates werekeen on TC2000 as a stock-screening tool (end of day in almost all cases).Some Reuters Graphics users felt that Reuters could do better but I hopethat these delegates managed to take a look at the state-of-the-artReuters software that was on display in the exhibitors hall. Coming froman FX world, it was strange not to hear TraderMade mentioned but thereseemed to be very few FX delegates on my side of the room.

Data feeds were a concern as the high price of live data was mentioned atevery group meeting. On the positive side, there were very fewcomplaints of bad data or spikes not being corrected. This is a hugeimprovement, and the Data Committee may want to take a bow aftermany years of lobbying the industry to clean up their act. Datastreamwas one of the favourite data feeds for the equity market participants,with e-signal, CSI and the TC2000 feed cited as well. Probably one of themost frequently mentioned pieces of software was Microsofts Excel, as atone time or another almost every table had a discussion about how toimport/export data and different uses for this software work horse.

Websites that the delegates used every day seemed to rotate aroundnews, quotes and charts. Lycos.com, yahoo.com finance, the FT, Wall St.Journal etc. all made it to the top of the list. Bigcharts.com andstockcharts.com were the favourites for stock market traders for chartingshares. Very few delegates mentioned chat rooms or bulletin boards.Whether this was because they had found the holy grail and did not wantto share it or because they simply did not use them was unclear but thefew who did mention them usually said that they were a waste of timeunless you signed up to the advanced levels. Systems developers seemedto prefer to use a combination of bespoke software, Excel andTradestation/Metastock and math software in their work. The keys formany of these practitioners were the ability to back test their strategies,and to look for risk analysis, stress testing and quantify their risk/rewardprofile.

For the future, the delegates on my side of the room seemed prettyoptimistic. Lower data and internet access prices were anticipated and itseems that we have become used to computers becoming easier to use,faster and cheaper every few years or so. It was interesting to hear thatnot one single piece of software seemed to be the catch all for most usersbut that a few pieces of software and data were still deemed necessary toget the job done. Maybe the knock out software that has all of the datahandling capabilities, portfolio functions, systems and modellingcapabilities plus the technical tools, macro writing, great charting plus acomprehensive data feed, all for very little money, is just around thecorner?

Gerry Celaya

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Please keep the articles coming in the success of the Journal dependson its authors, and we would like to thank all those who have supportedus with their high standard of work. The aim is to make the Journal avaluable showcase for members research as well as to inform andentertain readers.

The Society is not responsible for any material published in The MarketTechnician and publication of any material or expression of opinionsdoes not necessarily imply that the Society agrees with them. TheSociety is not authorised to conduct investment business and does notprovide investment advice or recommendations.

Articles are published without responsibility on the part of the Society,the editor or authors for loss occasioned by any person acting orrefraining from action as a result of any view expressed therein.

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IFTA walk about

Issue 46 March 2003 MARKET TECHNICIAN 3

BRONWEN WOOD 1942-2002

Bronwen was born in Australia, but her father was English and the familycame to England when she was a young girl. After studying at BristolUniversity she was first a teacher, then acted as a House Mother at aschool in America, but decided on returning to the UK that she wanted topursue a career in the City. She joined what was then HedderwickBorthwick, moving to Chart Analysis in 1971. From there she went toRowe and Pitman, which eventually became part of Warburgs, thenQuilter Hilton Goodison, which itself became part of CU. In 1993 sheaccepted a job at ADIA in Abu Dhabi, where she stayed until returning tolive in England in 1999.

In 1986, when the previous Association of Chart and Technical Analysts(ACTA) was incorporated and renamed the STA, the then Chairman, PhilipGray, and Bronwen decided that we needed to develop a formalqualification in the technical analysis field. So began the STA Diploma,and the courses leading to the examination. In the early years Bronwenwrote and marked all the papers. Those first students would not haverecognised todays type of course; in the beginning it took the form of asolid week of evening lectures, and that was it. However, even when shewent to work in Abu Dhabi from 1993 to 1999, Bronwen retained a livelyinterest in how the educational side of the STA was progressing, and wasvery impressed with the course as it now operates.

There are also many individual members who had their interest intechnical analysis fired or increased by talking to her and listening to herviews on the markets. Many of them have said Bronwen taught meabout technical analysis, not just at formal courses, but throughconversations with her.

In addition to her work for education in the Society, Bronwen was a greattechnical analyst, rated one of the best by her peers, particularly for herwork on the equity indices and individual shares. For both hercontribution to education, and for her outstanding analytical skills, shewas awarded the Fellowship of the Society in 1993.

Bronwen was also a long-standing member of the Board of IFTA and of itsExecutive Committee, most recently as Secretary as well as Chairman ofthe Nominations Committee. Through this connection, she was widelyrespected throughout the world, as well as in the UK, as an outstandingtechnical analyst and an expert in the teaching of technical analysis.

However, those who knew Bronwen will not remember her just for herteaching skills, the enthusiasm and integrity of her approach to technicalanalysis and her consummate professionalism. They will remember herlively and forthright conversation, her humour, her radiant smile andperhaps most of all her wonderful infectious laugh. All these things cannever be forgotten, and never replaced.

Bronwen died on 30 December 2002, aged only 60. In her memory, theBoard of the STA has voted to create an annual award for the bestDiploma paper. This will be known as the Bronwen Wood Memorial Prize.

HARVEY STEWART 1934-2002

Harvey was born in Dublin in 1934, moving across the Irish Sea with hisparents soon afterwards and was educated at Westminster School. Fromthere he won a scholarship to Trinity College, Cambridge. His first and - asit turned out only job was at Investment Research in Cambridge wherehe quite soon became the first ever business partner of the doyen ofEuropean technical analysis, Alec Ellinger. They were later joined by JohnCuningham, David Damant, Elli Gifford and David Charters.

Harvey was one of the founders of The Association of Chart and TechnicalAnalysts (ACTA) which became todays Society of Technical Analysts. Heserved at various times as the Treasurer and Membership Secretary andwas always an enthusiastic attendee of the monthly meetings. His workfor the society was recognised when he was awarded a Fellowship.Eventually his partners at Investment Research all became Fellows of theSociety a unique achievement.

After he had updated Alec Ellingers A Post-War History of theStockmarket, Harvey soon became an author in his own right whenHow Charts Can Make You Money was published by Woodhead-Faulknerin the 1980s. It became one of their best-selling titles.

The successful Cambridge conferences on technical analysis, which ranfrom the late 1960s for exactly 30 years, brought Harvey into contact withmany fellow technicians. Many will remember his extraordinary kindness,his drinking capacity and that voice rich, mellow and precise.

After retirement in 1984, Harvey moved to France, restoring a house inAutun, Burgundy, but he continued to return every year for the Cambridgeconference; for many years he wrote the official rsum. Eventually hereturned to live in the centre of Cambridge. His slightly premature deathin October 2002 from leukaemia, aged 68, is a great loss to us all. Harveywas a true Edwardian gentleman, born out of his time.

ANY QUERIESFor any queries about joining the Society, attending one of the

STA courses on technical analysis or taking the diploma examination,please contact:

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Scottish Conference

The Scottish Chapter of the STA is pleased to announce

that it will be holding the 3rd Annual Conference on March

21st, 2003 at the Caledonian Hotel in Edinburgh.

The guest speakers are Martin Scott (RBS), Julian McCree

(Manro Haydan), Julius de Kempenaer (Kempen and Co.)

and Raynard Cheng (CSFB). Murray Gunn (Standard Life

Investments) and Gerry Celaya (Redtower Research) will

represent the Scottish chapter as local speakers and we

hope to have Adam Sorab (Chairman of the STA) as the

keynote speaker at lunch. The previous conferences

proved very popular and we were literally at standing

room only levels at the 2nd Conference so early booking is

advised.

We would like to thank RBS Financial Markets, Reuters,

TraderMade and Redtower Research for their sponsorship

of this event and we look forward to seeing you there.

The conference fee is 60 for STA members/associates and

IFTA affiliates which covers the full day including lunch and

coffee breaks.

Please contact Katie Abberton at the STA Administrative

Services (tel. 07000 710 207) or email at [email protected].

Details are also at www.sta-uk.org/sta_in_scotland.htm.

Obituaries


A question often asked by traders after a breakout is, do I buy/sell thebreakout or wait for a pullback? The problem for the analyst is to decide ifa pullback will occur, or will the move accelerate away, leaving the traderstranded without a position. Technical analysis theory suggests that abreakout from a major consolidation range, reversal pattern, or even just abreak of a major trend line (support/resistance) will result in an initialsharp move in the direction of the breakout followed by a correctivepullback to retest the breakout point. But, as we are all aware, markets donot always behave exactly as textbooks describe. Indeed, false breakoutsresulting in reversals and runaway markets can make trading breakoutsextremely hazardous.

Hence, here we examine the behaviour of markets after a sharp move(which may or may not be associated with a breakout from a specific chartpattern) in an attempt to determine whether an optimal entry level can beeasily identified. For this exercise we have studied the case of US dollaragainst the Japanese yen (USD/JPY) given its tendency for sharp moves andvolatile trading behaviour. Indeed, USD/JPY has a reputation for generatinglarge moves, with moves of over one-percent per day not uncommon. Infact, in our test, we specifically examine moves of over one-percent within aday and analyse the trading activity in the following four days.

Specifically, we estimate the probability of USD/JPY continuing to attainextreme levels in the four days following a 1% or more move for a givencorrective pullback, ranging from a 10% pullback to a 100%-pluscorrection of the initial move. The sample data used for this estimationwas daily high/low/close data from January 1988 to January 2002, testingthe possibility of returning to an extreme level within four daysconditional upon exhibiting an initial 1% or more jump followed by acorrective pullback (see chart 1).

Chart 1

For a positive market jump of 1% or more in High[today]-Close[today-1]/Close[today-1], and then a pullback where (Close[today]-Close[today-1])/Close[today-1] is within a given range how many times have wereturned to the level High[today], within the following four business days?

Correspondingly, we also estimate the probability of attaining the lowlevel again after a large negative market jump of -1% or more.

In the sample data there were 470 cases meeting our criterion of a 1% ormore move to the upside. Of these 470 cases, 332 developed a correctivepullback (we defined corrective pullback as a counter move retracing atleast 10% of the initial jump or spike). On the downside, there were 508cases meeting our criterion of at least a 1% move, with 420 developing apullback. This initial finding is very noteworthy in itself, as it shows that inthe majority of cases, after a significant move in price action, there is infact at least a correction of the initial move. This would tend to supporttechnical analysis theory of a correction after a breakout, and to imply

that waiting to enter a position, rather than immediately entering themarket after a breakout, would be the preferred strategy. But the nextstep of the test is crucial as here we attempt to determine if there is anoptimal entry level, using the correction to establish a position inanticipation of a continuation of the trend in the direction of the initialbreakout.

Fibonnacci analysis is often used to estimate the extent of a potentialcorrective pullback (especially for the application of Elliott Wave Analysis),with the 38.2% and 50% retracement levels seen as targets for acorrection, which is likely to produce a continuation of the trend. It isperceived that retracements beyond the 61.8% level are likely to result ina full retracement of the previous move. With this theory in mind, weestimated the probabilities of USD/JPY returning to extreme levels for agiven percentage corrective pullback.

Indeed, we carried out a series of tests to determine the probability ofUSD/JPY achieving a new extreme level within the next four trading daysfor a given size of corrective pullback after the initial 1%+ move. Thecorrective pullback was measured as the percentage counter trend movefrom the intra-day extreme to the close. Tests were carried out oncorrective pullbacks in 10% point steps from the intra-day extreme,starting with a 10% pullback, right through to a 100%+ retracement of theoriginal move.

In fact, three tests were carried out, the first examining the probability ofUSD/JPY returning to the extreme level within four days after the initial1%+ move for cases pulling back more than the specified retracementlevel (Table 1). For example, study the case of Pblim = 0.9 (10%pullback). In 363 of the 470 cases the Close of that day, i.e. Close[today],is up by at most 0.9*X percent. Now, in 246 of these 363 cases, 68%, wereturned to at least the level of High[today] within the following fourbusiness days.

The second test examined the probability of USD/JPY returning to theextreme level within four days of the initial 1%+ move for cases pullingback NOT more than the specified retracement level - a pullback leadingto a Close[today] up at least (PBlim*X)% (and at most X%, that isClose=High), (Table 2). For example, study the case of Pblim = 0.9. For thewhole sample we have 470 jumps of at least 1%. In 107 of these cases theClose of that day, i.e. Close[today], is up between (0.9*X)% and X%. Now,in 105 of these 107 cases, 98%, we returned to at least the level ofHigh[today] within the following four business days.

The third test examined the probability of the extreme ( High[today] orLow[today] ) being achieved after a corrective pullback into a given range(see Table 3).

Detailed analysis of the results in Tables 1-3, reveals some interestinginformation about market behaviour, which appears to support technicalanalysis theory and general market perceptions. Indeed, these results areconsistent with the theory that following a breakout (here simulated bya 1%+ move) a corrective pullback should be expected and that ashallow correction will result in a continuation of the developing trend inthe direction of the breakout. Indeed, we found that in around 77% ofcases following a 1%+ rise, a pullback was witnessed, and that in 82% ofcases following a 1%+ decline a pullback was recorded. Of thesepullbacks we found that 74% in the case of an up move and 71% in thecase of a down move, registered a retracement of between 10% and 50%.Given that the vast majority of pullbacks after a sharp move higher fallinto the 10% to 50% retracement zone, a closer study of the observationsfalling into this category is justified, and indeed throws up someinteresting results. The results of our tests suggest that the probability ofUSD/JPY going on to extend the trend following a pullback of over 0.6(40% retracement) is greatly reduced and is in fact not that significantlydifferent from 50%. This is obviously consistent with the Fibonnacciretracement level of 38.2%.

Optimising entry levels for maximum riskcontrol

By Ian Stannard and Dr Petra Wikstrom

Close[today-1]

High[today]

Close[today]( 1%

Within following4 business days


Also of interest is the distribution of the successful cases (Chart 2 -distribution of successful cases in an upmove), which shows that the 0.8level (20% retracement) represents 50% of successful cases. Thedistribution chart falls away sharply to the 0.5 level (50% retracement),where there are only a very limited number of successful cases. Thisprovides further evidence to support the market perception that a limitedpullback (20% retracement) after a sharp move will result in acontinuation of the trend, while a deeper pullback (over 50% retracement)greatly reduces the chance that the trend will be resumed.

Chart 2 Distribution of successful cases following a 1% or more upmove. Pullbackversus density (numbers of cases). The area beneath the curve is 1.For PBlim around 0.80 divides the area in to two equal parts. That isaround 50% of successful cases have had a Close[today] between 0.8 and

1. The corresponding distribution chart of successful cases following a1%+ down move is very similar.

-1 .0 -0 .5 0 .0 0 .5 1 .0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

P B lim

de

ns

ity

Table 1:In the case of a pullback more than the specified retracement level. Close[today] at most Pblim*X. Number of cases returned within four days: Rethi, Retlow.

hi hilow hilowhi low lowhi lowhilow PBlim Rethi Retlow hiPB lowPB470 32 10 508 34 11 0 31% 32% 7% 7%470 37 14 508 41 15 0.1 38% 37% 8% 8%470 47 20 508 60 23 0.2 43% 38% 10% 12%470 58 24 508 74 29 0.3 41% 39% 12% 15%470 70 29 508 93 39 0.4 41% 42% 15% 18%470 96 44 508 121 59 0.5 46% 49% 20% 24%470 123 60 508 161 87 0.6 49% 54% 26% 32%470 177 96 508 225 128 0.7 54% 57% 38% 44%470 247 148 508 306 190 0.8 60% 62% 53% 60%470 363 246 508 420 288 0.9 68% 69% 77% 83%

Table 2:In the case of a pullback NOT more than the specified retracement levels. Close[today] between (PBlim*X)% and X%. Returned within four days: Rethi, Retlow.

hi hilow hilowhi low lowhi lowhilow PBlim Rethi Retlow hiPB lowPB470 439 341 508 475 361 0 78% 76% 93% 94%470 433 337 508 467 357 0.1 78% 76% 92% 92%470 423 331 508 448 349 0.2 78% 78% 90% 88%470 412 327 508 434 343 0.3 79% 79% 88% 85%470 400 322 508 415 333 0.4 81% 80% 85% 82%470 374 307 508 387 313 0.5 82% 81% 80% 76%470 347 291 508 347 285 0.6 84% 82% 74% 68%470 293 255 508 283 244 0.7 87% 86% 62% 56%470 223 203 508 202 182 0.8 91% 90% 47% 40%470 107 105 508 88 84 0.9 98% 95% 23% 17%

Table 3:In the case of a pullback within a specified region of between 0.9-0.7, 0.8-0.6, 0.7-0.5 and so on...

hi hilow hilowhi low lowhi lowhilow PBlim Rethi Retlow hiPB lowPB470 21 10 508 33 14 0.3 48% 42% 4% 6%470 23 9 508 33 16 0.4 39% 48% 5% 6%470 38 20 508 47 30 0.5 53% 64% 8% 9%470 53 31 508 68 48 0.6 58% 71% 11% 13%470 81 52 508 104 69 0.7 64% 66% 17% 20%470 124 88 508 145 103 0.8 71% 71% 26% 29%470 186 150 508 195 160 0.9 81% 82% 40% 38%

Table Key:

hi = Number of cases which moved higher 1% or more in one day.hilow = Number of cases that after moving higher 1% or more then pullback into a specified region.hilowhi = Number of cases that after a pullback into a specific region go on to achieve or exceed the previous high within the following 4 business

days (number of successful cases).low = Number of cases which moved lower 1% or more in one day.lowhi = Number of cases that after moving lower 1% or more then pullback into a specified region.lowhilow = Number of cases that after a pullback into a specific region go on to achieve or exceed the previous low within the following 4 business days

(number of successful cases).PBlim = The specified pullback region (0.9 = 10% retracement, 0.8 = 20% retracement etc.).Rethi = Probability of a pullback within a specified region achieving or exceeding the previous high within four business days.Retlow = Probability of a pullback within a specified region achieving or exceeding the previous low within four business days.hiPB = Percentage of cases that moved 1% higher or more in one day that achieve a specified pullback region.lowPB = Percentage of cases that moved 1% lower or more in one day that achieve a specified pullback region.


ConclusionThe results of the above tests suggest that following a sharp move in price(in this case a 1%+ move in USD/JPY), it is highly likely that a correctivepullback will follow. Although in most cases a new extreme level isreached after the pullback, the probability of the trend being resumed issignificantly affected by the extent of the corrective pullback. Indeed, wehave found that close analysis of the extent of the pullback significantlyincreases the probability of participating in a profitable trade byidentifying potentially more advantageous entry levels for investors toparticipate in a further extension of the breakout move.

We have found that the 0.6% pullback (40% retracement level) isextremely important. Indeed, there is a very high probability thatpullbacks that do not extend beyond this level will go on to extend thetrend in the direction of the breakout. However, pullbacks that extendbeyond the 40% retracement level have a much reduced probability ofextending the move. In fact, our tests show at this stage, the chances ofparticipating in a profitable trade are not significantly different from 50%.Given that the vest majority of pullbacks after a sharp move do in factremain limited (our tests found that 50% of pullbacks only retrace 20%), awell constructed trading strategy aimed at pullbacks of less than 40%should still provide a high level of participation. In the case of USDJPY, ourtests suggest that using the 40% retracement level as a cut off point, aninvestor would have only missed out on 17% of the potentially profitabletrading opportunities (although these 17% are potentially highlyprofitable given the favourable entry level that would have beenachieved) while avoiding 53% of the likely unprofitable situations.

APPENDIXTest Details

The probability estimates of returning to the extreme level, conditionalupon having exhibited a jump and a pullback in a certain range, areobtained by simply counting the number of times this has happened. Weuse chi-square statistics to test whether the conditional probabilities arestatistically different from 50%. For a 95% level or better, the p-value is atmaximum 5%, which therefore corresponds to a chi-squared value of atleast 3.84. Also a 90% confidence interval for all probabilities is given,where the upper and lower bound values each can be rejected on the95% level.

Test Statistics

Test Statistics key

ChiHi = Chi square for successful cases following a 1% or moremove higher for a specific pullback region.

pvalHi = P-value for successful cases following a 1% or more movehigher for a specific pullback region.

ChiLow = Chi square for successful cases following a 1% or moremove lower for a specific pullback region.

pvalLow = P-value for successful cases following a 1% or more movelower for a specific pullback region.

CintUPhi,CintDownhi = 90% confidence interval for successful cases following a

1% or more move higher for a specific pullback region.CintUPlow,CintDownlow = 90% confidence interval for successful cases following a

1% or more move lower for a specific pullback region.

Ian Stannard is Senior Currency Strategist, and Dr Petra Wikstrom is Quantitative Analyst at BNP Paribas

Test 1:

In the case of a pullback more than the specified retracement level

ChiHi pvalHi ChiLow pvaLow CintUPhi CintDownhi CintUPlow CintDOWNlow

4.50 0.034 4.24 0.040 49% 18% 49% 19%2.19 0.139 2.95 0.086 54% 24% 52% 24%1.04 0.307 3.27 0.071 57% 30% 51% 27%1.72 0.189 3.46 0.063 54% 30% 51% 29%2.06 0.151 2.42 0.120 53% 31% 52% 32%0.67 0.414 0.07 0.785 56% 36% 58% 40%0.07 0.787 1.05 0.306 58% 40% 62% 46%1.27 0.260 4.27 0.039 61% 47% 63% 50%9.72 0.002 17.9 0.000 66% 54% 67% 57%45.8 0.000 57.9 0.000 72% 63% 73% 64%

Test 2:

In the case of a pullback NOT more than the specified retracement levels


134.5 0.000 128.4 0.000 81% 74% 80% 72%134.1 0.000 130.6 0.000 81% 74% 80% 72%135.0 0.000 139.5 0.000 82% 74% 82% 74%142.1 0.000 146.3 0.000 83% 75% 83% 75%148.8 0.000 151.8 0.000 84% 76% 84% 76%154.0 0.000 147.6 0.000 86% 78% 84% 77%159.1 0.000 143.3 0.000 87% 80% 86% 78%160.7 0.000 148.5 0.000 90% 83% 90% 82%150.2 0.000 129.9 0.000 94% 87% 93% 85%99.1 0.000 72.7 0.000 99% 93% 98% 89%

Test 3:

In the case of a pullback within a specified region


0.05 0.827 0.76 0.384 68% 28% 59% 27%

1.09 0.297 0.03 0.862 59% 22% 65% 33%

0.11 0.746 3.60 0.058 68% 37% 76% 50%

1.53 0.216 11.5 0.001 71% 45% 80% 59%

6.53 0.011 11.1 0.001 74% 53% 75% 57%

21.8 0.000 25.7 0.000 78% 62% 78% 63%

69.9 0.000 80.1 0.000 86% 74% 87% 76%

STA DIPLOMA EXAMINATION

The diploma examination will be held on Friday25th April 2003 at London School of Economics,Houghton Street, London WC2A 2AE. Registrationis at 12.45pm and the exam lasts for three hours.The entry fee is 350.00.

If you wish to sit this exam, please contact:

STA Administrative ServicesDean House,

Vernham Dean,Hampshire SP11 0LA

Tel: 07000 710207 Fax: 07000 710208www.sta-uk.org

REVISION DAY

An essential for serious candidates 2001 diploma candidate.

Prior to the exam, there will be a one day revisioncourse on Friday 4th April 2003.The cost (includinglunch) is 250.00. Those wishing to attend shouldcontact STA Administrative Services.


Characteristics of fluctuations in the Japanese and USstock markets.Looking at daily stock price changes, the Japanese stock markets aresignificantly affected by the fluctuations in the US markets. The US marketopens half a day later than the Japanese market. But when placed in theorder of influences, the US market gives influences to the Japanesemarket one half a day later, as can be seen in Figure 1. The U 1, namely,up 1 in Figure 1 shows the first rise in the US market while the IU 1,namely,influenced up 1 shows a rise in the Japanese market, influencedby the US one. The influences of the U 6 appear in a form of the IU 6half a day later. However, daily minute changes as above are differentfrom a long-term trend. As far as a trend is concerned, the Japanesemarket does not always follow the US one. This means that in some casesthe Japanese market is bullish while the US one is bearish, and in othercases it is bearish while the US one is bullish. Past history providesevidence of this. Figure 2 indicates the mechanism in which both marketsdo not show coincident trends while they are closely interlocked in ashort time span. As you see in Figure 2, daily U 1 and IU 1, and U 7 andIU 7 coincide with each other, but a lack of correlation is seen whenviewed from a trend level (namely, trends are in opposite directions).

During the period from the end of the Second World War up to now, stockprice trends in the two markets have often not been moving in the samedirection. For further details, refer to Figures 3 and 4. Figure 3 indicatesthe history of the dollar-denominated Nikkei Dow and Figure 4 indicatesthe history of the New York Dow, both from the end of the War up to now.Both indicate dollar-denominated monthly charts with the axes of pricesin a logarithmic scale. I will now look at the changes in both Dow valuesin the two countries during the 40 years from the beginning of 1960 toOctober 1999. For the purpose of comparing correlations, I divide theperiod into four phases as defined by:

Phase 1 (I in Figures 3 & 4) 6 years from the beginning of 1960 to the endof 1965;

Phase 2 (II in Figures 3 & 4) 17 years from the beginning of 1966 to theend of 1982;

Phase 3 (III in Figures 3 & 4) 7 years from the beginning of 1983 to theend of 1989;

Phase 4 (IV in Figures 3 & 4) 10 years from the beginning of 1990 to theend of 1999 (For 1999, as of October).

In Phase 1, the New York Dow rose while the Nikkei Dow fell. The reasonfor this disparity is found in the fact that, while the US economy wasenjoying a period of prosperity in the Sixties, Japan experienced amedium-term correction stage called securities depression.

In Phase 2, the New York Dow showed no significant fluctuations over along period while the Nikkei Dow indicated a long-term up-phase. Thiswas caused by the US economy being in the long-term doldrums while inJapan there was long-term high growth. The US down-turn was broughtabout by the Vietnam War, the reduction in dollar value, chain-reactedbankruptcies of savings and loan associations, rapid growth and collapseof the two-tier market in New York, the socio-political disorder of theWatergate scandal, and so on. On the other hand, the long-term highgrowth in the Japanese economy was the result of a high marginalgrowth rate. Growth started from zero after the last war, with a rise in thegeopolitical significance of Japan in the advance of the East-West coldwar, gradual and continued rise in land prices, the introduction of newtechnologies from Europe and North America and the promotion of

Asset allocation in Japanese and US stockmarkets by means of technical analysisSummary of presentation to IFTA 2002 Conference By Hiroshi Okamoto

Figure 1

Figure 3

Figure 4

Figure 2


technological improvements by Japanese companies, comprehensivecorporative labour relations, political stability, and so on.

In Phase 3, both the New York Dow and the Nikkei Dow rose. This is theonly period after the War when both Japanese and US stock markets keptpace with each other. However, the Japanese economy was in the grip ofa bubble and developed a more speculative, dynamic upward market.This will be verified later, from a technical viewpoint, by using netmomentum which means the balance of the momentum of the New YorkDow subtracted from that of the dollar-denominated Nikkei Dow.

In Phase 4, the New York Dow rose while the Nikkei Dow fell. The oppositetrends were the result of long-term stable growth in the US and a rapidcollapse of the bubble economy in Japan. During this period, all the newand old industries in the US showed a favourable performance. While oldenterprises promoted restructuring to improve their profit structures,venture-capital organizations and other groups of enterprises entered thestock market one after another. In the Japanese industrial world, on theother hand, values of all the capital stock, including land and corporatestocks, were abruptly reduced, and future corporate activities were greatlycurtailed. Moreover, many industrial sectors lost their growth potentialand many companies crashed. The Government was slow to introducemeasures to counter the down-turn and failed to implement structuralreform of financial markets and industry.

I will now move forward to the three years since November 1999 notcovered in Figures 3 and 4. In analysing this period, I have tried to developa universal methodology of technical analysis that involves a little moretechnical and scientific analysis. I have concentrated on trend analysis.We usually classify trend analysis into regular time-series analysis andirregular time-series analysis.Briefly, the regular time-series analysis isrepresented by that of moving average lines and the irregular time-seriesanalysis, by point and figure charts. In practical application, they involvetheir own merits and demerits, and analysts may choose either to theirliking. I am going to consider the moving average line analysis and thefollowing is my concept of this analysis.

The moving average lines of the stock indices are plotted, as you know, ina manner to place an averaged value over an averaging period at its end.This method allows the lines to smooth initial series of values and, at thesame time, the lines have the effects of delay.The term effects of delayis explained as follows: we draw an upward trend line by connecting lowprices when the market is in an upward trend; on the other hand, we drawa downward trend line by connecting high prices while the market is in adownward trend. Effects of delay means that the moving average linecan take the place of these upward and downward trend lines. Generallyspeaking, classic trend lines have a defect in that they cannot be drawnuntil the market proceeds to a certain degree. The new trend line that isrepresented by a moving average line has the merit of drawing from thestart of the market movements.

On the other hand, the issue of delays in the moving average lines marksa weak point of technical analysis. This is applicable, in particular, whencycles are relatively small-scale in the market. Immediately after a reversalof a trend is confirmed, if the market cycle is small, another reversal issometimes found there. This means the occurrence of a misleading signal.I wondered if I could develop a moving average line having smoothingeffects and small delays (or less misleading contents), as a moving averageline such as that would be an ideal one. Now the technique that more orless realises this ideal line is the Okamotos moving average line.

The moving average lines I have successfully devised are based onstatistical methods. Namely, I plot an averaged value, not at the end of anaveraging period, but at its centre. Taking an example of a nine-daymoving average, the day on which the averaged value is positioned is atthe centre of the nine days, or the fifth day. This method allows me tosmooth initial series of data values without fear of delays. However, thismethod is not exempted from demerits. Since the nearest average valuefalls on the fifth day, there are no average values for the remaining fourdays. To fill in the blanks, I have found the following remedy. Use aregression analysis to estimate future stock prices and strike averagevalues based on such estimated data.

Take an average of actual stock prices from the first to ninth days andposition it on the fifth day. This is the usual statistical way. For mymethod, however, make linear regression of stock prices for five days,namely, from first to fifth, and estimate stock prices for the four days alongthe regression line. Then, take an average of the actual stock price for the

five days used in the regression analysis followed by the newly estimatedstock prices for the four days, and use the average value thus found asthat for the nine days to be located on the fifth day. In this way, we cancalculate a moving average line to the last item of the initial series ofvalues. It is the Okamoto style that prepares an average line by addingone day after another to an averaging period and taking average values inthis way.

Now, have a look at Figures 5 and 6. The upper portion of Figure 5combines the dollar-denominated Nikkei Dow, which is a monthly chart,with a 48-month moving average line. The upper portion of Figure 6combines the New York Dow for the same period with a 48-monthmoving average line. Both are Okamoto-type 48-month moving averagelines. I believe you will find the average lines are not so much behindactual stock prices in either figure. If I attempt to plot a 48-month movingaverage line that is ordinarily used in the stock market, I arrive at Figure 7.You will find a clear difference between Figure 7 and the upper portion ofFigure 5. In conclusion, Okamotos trend-line technique is characteristic ofsmoothing the movements of stock prices with relatively small delays.

The lower portion of Figures 5 and 6 indicates the momentum of themoving average lines shown in the upper one. The momentum in thisexample represents ratios of the moving average lines changing from theprevious month. Since it shows changes from the previous month, it isnaturally located in the positive zone if the market trend is upward and inthe negative one if it is downward. Be sure that any changes in thepositive/negative signs will suggest trading timing for the markets.

Looking at Figures 8 and 9, the upper portion of both figures indicatestransitions in Dow average in Japan and the US. I have given a specialdevice to the lower one for the purpose of technical analysis. In otherwords, it indicates the net momentum that means the balance of themomentum of the New York Dow subtracted by that of the dollar-denominated Nikkei Dow. The net momentums in both figures are thesame. Note that, in these figures, I adopt momentums compared withthose six months before, instead of those compared with one month

Figure 5

Figure 6


before and that the net momentums are based on data compared withthose of six months before. You will find that this processing has madechanges in the signs far more identifiable when compared with those inFigures 5 and 6.

Generally speaking, momentums are used to find buying signals whenthey shift into the positive zone and to find selling signals when they shiftinto the negative zone. However, the net momentum has a differentmeaning. Shifting into the positive zone suggests superiority of the USmarket while shifting into the negative one favours the Japanese market.The shift into the positive zone shown in the lower portions of Figures 8and 9 means that we should sell Japanese equities and buy US ones, whilethe shift into the negative zone means that we sell US equities and buyJapanese ones. Therefore, the net momentum acts as a reliable indicatorfor asset allocation between the Japanese and US markets.

Verification of the net momentum by applying pastdataNow, lets verify what degree of results we may secure if we should applythe net momentum for reciprocal operations in the Japanese and USmarkets over the past 40 years. For the verification purposes, I apply the

following trading rules:

1. Although shifts in the net momentum are confirmed at the end of amonth, we assume that trading is made at the prices prevailing at the endof that month.

2. Ignore fees, interest, taxes, etc. related to the trading, and exclude themfrom computation.

3. Use monthly charts since the beginning of 1960 for this verificationpurpose by means of the indices of the dollar-denominated Nikkei Dowand New York Dow.

4. Always start trading with buying and avoid short sales.

When taking an overview of the 40 years from 1960 to 1999, I found atotal of 22 cases in which net momentum crossed the zero line, as shownin the data in Table 1. Out of the 22 cases, eleven were a shift from thenegative into the positive zone (namely, shifting portfolio allocation to theNew York shares) and the other eleven were a shift in the oppositedirection (namely, shifting portfolio allocation into Japanese shares).

Notes1. Abbreviations N1 to N11 represent trading of NY Dow.2. Abbreviations T1 to T11 represent trading of dollar-denominated

Nikkei Dow.3. Unit in dollars for both NY Dow and Nikkei Dow.4. Periods held are based on months.5. The rates of profit and loss (converted into annual ones) are

expressed in percentages.6. Price data based on gross data from Graphs 1 to 8.7. Asterisk (*) indicates extremely short-term trading as a result of

delicate or unexpected movements in the market.

ConclusionThese 22 cases resulted in 16 profitable trades and 6 unprofitable trades.In other words, the success ratio based on the number of cases was 72.7%(16/22 = 0.727).

The time required for a net momentum to switch from one market to theother was, on an average, 20.6 months or one year and a half or more, for atotal of 22 cases. This can be regarded as the average maintaining time ofa trend for a trading. This means that, once it is determined whether weshould be in New York or Tokyo, the investment funds remain in thismarket, on average, for one and a half years. This seems to me reasonable,judging from an average sight of 48 months for short-term businesscirculation.

It should be noted that there were two misleading shift signals over a veryshort term. These occurred in October 1985 in the New York market andin March 1992 in Tokyo. Both of them occurred as a temporaryphenomenum in a long-term upward process and indicated a new shift inthe subsequent month, earlier than usual. The final shift was in July 1999 shifting from New York to Tokyo.

AnnualDate Stock Date Stock Periods Rates of rates of

purchased price sold price held profit profit oror loss1 loss1

N1 61.12 731.14 63.5 726.96 17 0.57 0.40

T1 63.5 4.32 63.10 3.77 5 12.7 30.48

N2 63.10 755.23 65.12 969.26 26 28.3 13.06

T2 65.12 3.94 67.7 4.10 19 4.0 2.52

N3 67.7 904.24 68.8 896.01 13 0.9 0.83

T3 68.8 4.73 71.1 5.83 29 23.2 9.60

N4 71.1 868.5 71.12 890.2 11 2.4 2.61

T4 71.12 8.07 74.3 15.83 27 96.1 42.71

N5 74.3 846.68 76.10 964.93 31 13.9 5.38

T5 76.10 16.01 79.8 29.54 34 84.5 29.82

N6 79.8 887.63 80.12 963.99 16 8.6 6.45

T6 80.12 33.92 82.8 27.52 20 18.8 11.28

N7 82.8 901.31 83.12 1258.64 16 39.6 29.70

T7 83.12 42.21 85.10 60.25 22 42.7 23.29

N8 85.10 1374.31 85.11 1472.13 1 7.1 85.20

T8 85.11 62.73 89.7 248.39 44 295.9 80.45

N9 89.7 2660.66 92.3 3235.47 32 21.6 8.10

T9 92.3 145.79 92.4 130.20 1 10.6 127.20

N10 92.4 3359.12 93.5 3527.43 13 5.0 4.61

T10 93.5 186.45 95.2 173.59 21 6.8 3.88

N11 95.2 4011.05 99.7 10655.15 53 165.6 37.49

T11 99.7 154.96 99.10 166.61 3 7.5 30.00

*

*

*

Figure 7

Table 1

Figure 8

Figure 9


Excluding these three cases, and using a total of 19 cases instead of theabove-mentioned 22, the average trading period is slightly prolonged to23.7 months. If we exclude the three very short-term cases mentionedabove, the average trend-maintaining periods in Japan and the USbecome almost equalized. They are 24.5 months in Japan and 22.8months in the US.

When making further analysis of the periods in which trends continued,periods continuing for 2 years (or 24 consecutive months) or more,recorded a total of 8 out of the significant 19 cases, with four in Tokyo andanother four in New York. Periods continuing for one year (12 consecutivemonths) or more recorded a total of 17, or 8 in Tokyo and 9 in New York.The fact that trends continued for one year or more in 17 out of a total of19 cases demonstrates that this technique is reliable. Therefore, I believe itcan be used to trigger signals for investment funds that are shifting assetsbetween the two countries.

The longest investment period lasted from November 1985 to July 1989 inthe Tokyo market, with the margin being 80.45% per year. This periodcorresponded to an exceptional case where both Japanese and USmarkets rose as described above. I will now look at the question ofmargin (or profit rate to invested amount). When reviewing the profit rate(converted into an annual one) produced by a total of 22 trading cases,the average was 13.94%, with the highest at the above-mentioned latterhalf of the1980s in Tokyo (or 80.45%) and the lowest from May to October1963 in Tokyo (-30.48%). As a matter of information, negative rates werefound in a total of 6 cases, far below the 16 cases of positive ones.Needless to say, these negative trading cases included the misleadingsignals.

When reviewing the shift signals, negative trades occurred twice in the USand four times in Japan. The reason why they occurred more in Japan isbecause they included two trading cases after the collapse of the bubbleeconomy. My investigation of these two negative cases revealed anextremely low -127.20% (per year) in the very short term from March toApril 1992, followed by -3.88% (per year) in the 21-month case from May1993 to February 1995.

With reference to the trading in the 1980s, funds were shifted to theTokyo market even though the New York one indicated positivemomentum. This was a case of a misleading trade, in which funds wereshifted to New York for a short period: only a month from October toNovember 1985. However, other cases produced substantial investmentresults, namely, profits of 23.29% per year in 22-month trading fromDecember 1983 to October 1985 and 80.45% per year in 44-monthtrading from November 1985 to July 1989.

We need to pay attention to the following fact: this technique backed bynet momentum suggested asset allocation always shift funds into NewYork market during and after the collapse of the bubble economy inTokyo. Generally speaking, as a result, international fund managerssucceeded in protecting their funds from long-term downward markets inTokyo and, also, they could enjoy the long-term prosperous movements inthe New York market.

Changes on and after November 24, 1999My next investigation covers changes on and after November 24, 1999. AsFigure 10 clearly shows, a signal suggesting a shift to Japanese shares inJuly 1999 did not continue for long. In October 2000, net momentumshifted again, therefore the period suggesting investment in Japan cameto an end in the 15th month and funds were again shifted into the USmarket in October 2000. However, in August 2002, the net momentumwas converted once again, suggesting another shift into Japan.

The period from July 1999 to October 2000 lasted for 15 months, and theperiod from October 2000 to August 2002 lasted for 22 months. Althoughneither case involved misleadingly short-term tradings, net momentumswere converted more frequently than ever. In my opinion, it is high timefor Japanese shares to maintain relative superiority. I will explain thereasons why.

By definition, the capitalistic economy is a system that uses human desiresfor wealth as the prime mover for its development, and by nature, it tendsto go out of control. Since the experience of the US in the 1920s, we havedevised some mechanisms to control such runaways, including but notlimited to, the reformation of the Banking Law, Securities Law, andSecurities Exchange Law.

At the very end of the 20th century, however, people began to believethat the market was an all-rounder. They were put under pressure tofurther liberalise the financial systems and they forgot about pastexperience. So they supported the gradual removal of such controllingmechanisms that they had once welcomed. The enactment of theGramm-Leach-Bliley Act finally paved the way to complete liberalisation.

Since banks added security businesses to their conventional operations,the financial system displayed signs of excessive growth, thereby causingbubbles to appear once again. As a result, L.S.De-ism flourished, fraudflew high, while morals diminished. Although the Bush Administrationenacted a corporate reformation act, this will hardly solve the problems.In my opinion, more powerful, elaborate, controlling mechanisms shouldbe produced. Im afraid I may be too pessimistic, but I believe it will take10 years before the US market fully recovers. In my view the same isapplicable to many countries that introduced the US model for promotingtheir financial big bang.

What about Japan? Japan is also to blame in so far as it intended to causebig bang by introducing an American model. However, Japan differs fromother countries in a number of ways. The first of these is that the bubbleeconomy started and collapsed 10 years earlier than in other countries,with its economy remaining in the doldrums and the stock market beinginactive for the past 10 years. This means that the stock price level hasbeen sufficiently low and there isnt much room for further falls.

The second is that the Koizumi Cabinet has started reviewing itseconomic policy in a forward-looking manner, though it is extremelydelayed. The third is that people are steady in the case of Japan. It is truethat more than ten years ago some individual investors were caught outby the bubble economy and were considerably damaged in the finalstages. As is often told, individual financial assets in Japan are fairlysufficient, reaching about five times the total market capitalisation ofTokyo Stock Exchange. Individual investors in Japan are still too careful,but it is anticipated that they will not endure the continuation of zerointerest rates any more.

If the relevant ministries and agencies take correct policies, includingdrastic reformation of tax systems for securities, it is quite probable thatindividual investors will rush into the securities market. The fact that mynet momentum theory has indicated Japanese superiority in these years,I hope gives us a signal of new streams into the market. As I have alreadysuggested, it is the truth in the past that, if the sun sets in the US, it rises inJapan.

This article is based on the IFTA test paper I prepared in autumn 1999 andso for further background information, please refer to the IFTA Journal,2000.

Hiroshi Okamoto runs his own consultancy business and took over asChairman of IFTA in January 2001.

Figure 10


Introduction

Since joining a Japanese bank six years ago I have been fortunate enoughto be introduced to the Japanese method of charting called IchimokuKinko Hyo. My Japanese colleagues who are very familiar with thismethod of analysis, have used it over a wide range of markets.

The Kanji, the Chinese character for Ichimoku, means at a glance, Kinkomeans balance, while Hyo simply means charts. Sanjin Ichimoku was thepseudonym used by a Mr. Goichi Hosoda who devised the method in the1960s when trading stocks. The central concept is the trend of the market.

In a previous issue of the Market Technician (April 2001, Issue No 40) Iwrote an introductory article about Ichimoku Kinko Hyo charts. I willtherefore, outline very briefly the main principles of this technique beforegoing into detail about how this type of charting can improve profitabilitywhen trading options. Anyone who would like a more detailedintroduction can refer to my previous article.

Daily candlesticks are used for the charts which means that the system isgeared to medium to long term strategies and is not suitable for jobbersand day traders. We then analyse the candle charts for reversal patterns,which I find are often clearer than those on bar charts.

Two moving averages are added to the daily candlestick chart: a nine day,called Tenkan-sen, and a 26 day, called Kijun-sen. The number of daysused is based on the fact that in Japan they used to work a six day week.There are, I believe, 26 working days in the average month.

The moving average does not use the closing price. We use the averageof the days range: high plus the low divided by two. This is probably atruer indication of the days activity, particularly for markets where theclosing price is at some arbitrary time, like foreign exchange, and in thinmarkets where the closing price may be manipulated.

The crossover of the two lines gives buy and sell signals as withconventional moving averages. To these, the two lines that make up theclouds are added. The first, known as Senkou Span A, is calculated byadding the Tenkan and Kijun values and dividing by two. The line is thenplotted 26 days ahead of the last complete days trading.

The second line, imaginatively called Senkou Span B, is calculated byfinding the highest price of the last 52 days, adding to it the lowest priceof the last 52 days, and dividing by two. This is also plotted 26 days ahead.So, although they have the same name, their construction is very different.

The clouds have a variety of uses and add a completely new dimension tothe chart. Firstly, if todays candle is above the cloud, the trend is forhigher prices. The top of the cloud is the first level of support and thebottom of the cloud is the second level of support. From experience Ihave seen that these really do often work, but one has to give them a littleleeway.

The opposite is the case when candles are below the cloud, with thisbecoming the area of resistance. Very often the market seems to movethrough the first support/resistance level and fails somewhere in themiddle of the cloud. When this happens we watch the shape of the dailycandlesticks to see if they give a reversal signal.

Clouds can be very useful in adjusting a basic trading position. Partialprofits can be taken or tentative new positions can be entered intowithout waiting for the moving averages to cross.

The thickness of the cloud is also important. The thicker the cloud, theless likely it is that prices will manage a sustained break through it. Thethinner cloud suggests a successful break is a lot more likely.

This gives an idea of when the market is likely to change trend. It givesdates (usually three or four days around the central point) when there isan increased chance of a successful move through the cloud area. Thedistance between the cloud and the current price is not significant.

Chikou Span

The final line to be added is the Chikou Span. It is merely todays closingprice plotted 26 days behind the latest daily close. This is used incombination with the latest candlestick. If Chikou Span is trading abovethe candlestick of 26 days ago, then todays market is said to be in abullish long term phase. Conversely, if Chikou Span is trading below thecandlestick of 26 days ago, then todays market is in a long term bearishphase. The same idea applies to Chikou Span and the clouds; if it is abovethe clouds of 26 days ago, this suggests a bullish outlook and vice versa.Finally, the position of the candlesticks and the clouds are also levels ofsupport and resistance for Chikou Span. These will give suggestions ofwhere todays support and resistance will lie.

Try to visualise it as follows: in a bull market Chikou Span and the cloudsprovide a solid base, and above you is nothing but clear blue skies whichwill not hamper your way up. Conversely, in a bear market, Chikou Spanand dark heavy clouds will grind you down and push you lower.

Option Examples: Strategies where options are bought.

This is a good example for a cautious investor who wants to buy an out ofthe money option. In this example the investor anticipates that theAustralian dollar should increase in value versus the US dollar. The chart isof the number of US cents needed to buy one Aussie dollar (the level hereis 0.5400, so 54 US cents). The higher the price, the stronger the Aussie.Believing it should move higher, he therefore wants to buy an Aussie call(the same thing as a US dollar put).

First check the cloud and make sure the candlesticks are above the cloud.If they are not wait, as a lot of time value may be eroded as prices canstick under the formation for several weeks. If they are nudging into thecloud and the investor really cannot resist the urge to buy, choose a callwith a strike at the top edge of the cloud and preferably above it (to thenearest round number as these are more actively traded and thereforemore keenly priced) for example, the 0.5500 calls. As prices break abovethe top of the cloud, they are likely to start moving quite quickly,increasing implied volatility and thus adding value to the option.

Option strategies using Ichimoku Kinko cloudsSummary of presentation to IFTA 2002 Conference By Nicole Elliott

Australian Dollar

Sterling/dollar with clouds

Cloud made up of the differencebetween Senkou Span A and SenkouSpan B

daily candlestick

Chikou Span

Nine day moving average(Tenkan-sen)


This call can be held until expiry so long as prices do not break below thebottom of the cloud. If they trade down below this line, it will probably beworth selling out the option in order to recoup some time value andpossibly higher implied volatility. Note that, as and when prices movehigher, so does the cloud. It continues to provide support as the marketrallies and can be used as a trailing stop. Many investors do not thinkabout selling their options, especially in-the-money ones. But if you wantincreased profitability you should re-assess positions continually to makesure you have the best strategy for current market conditions.

In my next example, an investor wants to buy a put on the dollar versusthe Norwegian krona in the expectation that the rate will hold below thecloud formation. This rate is quoted the European way, i.e. as Krona perUS dollar, so the lower the rate, the fewer krona are needed to buy one USdollar. Ideally, the cloud should be thick and not have the lines crossingover within the next 26 days. This is not quite the case in this example butit is difficult to find perfect examples in current markets and I alwaysprefer to use up-to-date examples rather than historical ones. It is alsoimportant to check that Chikou Span (the grey line) is below the candle of26 days ago and below the cloud in this case NKr 7.5000. The investorthen buys a put with a strike just below this level, thereby increasing thechance of buying an option that is likely to move into the money quickly.

If the investor is correct, the two cloud levels should come lower over thelife of the option. This time the upper level is used to cut the position tominimise premium losses.

A similar, if more elegant, strategy to buy options can be achieved with aknock in, which tends to be a lot cheaper than a conventional option. Aknock in is an option that only comes into existence when a pre-agreedprice level is reached. Premium is paid up front, on the day of purchase,but if the knock-in level is not reached it never becomes a live option.For calls, the knock-in is usually below the current price and well belowthe strike price and vice versa for a put.

An investor who is bullish of the US dollar versus the Thai baht (the higherthe price, the weaker the baht), could do the following: buy an out of themoney call with a strike at the upper edge of the cloud, say 42.500. Alevel between the Chikou Span and the cloud crossover, which is alsobelow the current price, would be used as the knock in price, say 41.750.A minimum of one week, up to a maximum usually of one monthshould be used for the knock-in period for an option that has three

months to expiry. The option is therefore much cheaper than astraight call as the market a) may never drop to the knock in ratebefore rallying, or b) may reach this level after the knock-in period hasexpired (and so the option never comes into existence).

A similar strategy would be a reversal knock in. Assuming we arecurrently below both levels of the cloud, the knock in could be at thelower cloud level and the strike above the top of the cloud. Whileneat, this strategy would not really save you very much money andcertainly not nearly as much as using the standard knock in that wasillustrated above.

A knock out option strategy would again make the option slightlycheaper. This is an option which exists from day one, but then ceasesto exist or dies if a pre-determined price is touched.

In the next example I looked at the Singapore dollar versus the USdollar; the lower the rate, the stronger the Sing. dollar.

Because the current price is below a decent-sized Ichimoku cloud Iwould suggest the following strategy. Buy an at-the-money put on theUS dollar (a call on the Sing) at 1.7400. Use a level well above theupper edge of the cloud and above the Chikou Span as the knock outlevel, say 1.7700. So, if the market went against the investors strategy,his option would cease to exist as prices break above the top of thecloud. The most important thing is that the knock-out makes theoption cheaper to buy in the first place. In the event the US dollarrallied against the Sing. dollar and so this trade was effectively killedoff.

It may seem strange to suggest a loss-making strategy, but what I amtrying to point out is that cutting losses is just as important as creatingprofit-making situations to enhance returns. Ichimoku charts help todecide sensible stop-loss levels which avoid day-to-day noise in themarket.

The last strategy involving only buying options. This is a WindowKnock out/Knock in which capitalises on the timing aspect of optionsand Ichimoku. Windows are options where the knock in and/or

Thai Baht

Norwegian Krona

Singapore Dollar

Japanese Yen


knock out elements are shorter than the expiry of the option and arefor a pre-selected window of time, say a particular fortnight in the firstpart of the life of the option. These are even cheaper than straightknock-ins/outs in that not only must the trigger level be hit but itmust be hit within the right time frame.

To illustrate this example, we will look at the US dollar versus theJapanese yen, again quoted the European way as yen needed to buyone dollar: the higher the rate, the weaker the yen.

In an ideal world it is nice to see sharp price swings initially as thesetrigger the knock-in (but might just kill it dead too!), followed bysteady moves later on where you dont have to worry about youroption unexpectedly expiring on you.

The idea is that, ahead of the cloud becoming very thin, the investorbuys the option assuming that there will be fairly sharp moves at thethin point and eventually a change in trend. Once the new trend hasbeen established, one wants to run the trade and not worry aboutgetting stopped out. In this example I have assumed that we shall begetting some very sharp moves around mid-October, and that we shalleventually get a turn in the long term trend and that dollar/yen willeventually move up towards 130.00 around the year-end.

The key element of this strategy is that we want to buy a three monthdollar call as our long term view is for higher prices. Say a three monthat-the-money call at 122.00. Why here? This level is above the top ofthe cloud and just above Augusts high at 121.50. Because impliedvolatility is likely to increase in mid-October, I have taken the view thatit is better to buy now rather than wait and have to pay morepremium.

The next step is to reduce the cost which I can do via a knock-in forthe two weeks around the 10th October, which is the thinnest bit ofthe cloud. It is usual to put a knock-in a bit above the thinnest bit ofthe cloud as a) you should not be too greedy and b) the knock-in issaving such a lot of money that there is some leeway on the choice oftrigger price. So, above 118.00 and lets settle for 119.00.

As for a knock-out, I think that if dollar/yen broke to a new low for theyear, I should probably abandon this whole idea, so lets add a 115.00knock-out lasting for the first month of the option. Again this willreduce the premium I will have to pay on day one when I enter intothis trade. Premiums are so much lower with these add-ons because Iam in fact giving away optionality/betting against the trend. The costof this strategy is as follows: A straight three month 122.00 call wouldbe 1.8%, i.e. a percentage of the amount you want to do. So on onemillion dollars that would cost $18,000.

The same strategy using a two week knock-in at 119.00 for the middletwo weeks in October reduces the cost of the call to 0.32%, $3200. Tothe above we can add a one month knock-out (for the first month) at115.00, reducing the cost of the option yet further, to 0.16%, $1600.Less than one tenth of the price of a conventional call, which is not aninconsiderable saving. Furthermore, the rate of return relative tomoney tied up is dramatically higher. The result is greatly enhancedprofitability.

Strategies involving the sale of options

So far we have just considered strategies that involve buying options, butbankers are more likely to be selling options. This is banks naturalbusiness; we tend to buy options only to cover existing positions, toreduce exposure, or as part of a more complex trade. Selling is a steady iftricky business and I have heard it likened to picking up pennies in frontof a bulldozer.

First, selling a call to an investor.Decision one: where to pitch the strike? Usually the investor decides,but the grantor can increase or decrease the level of implied volatilitydepending on whether he really wants to pick up premium at theinvestors level. Strikes at new highs and new lows tend to be slightlymore expensive but, as fewer Western people know where the cloudsare, we can use these as well as new highs and lows.

Strikes at the top of the cloud could and should be more expensive,

while those within the cloud can be pitched more cheaply. This is

because the market is likely to get stuck inside the cloud (if it is thick),

using up time value. Theta, time decay, is the option sellers friend. If

only all options sold expired worthless.

Decision two: when to hedge the call as it moves into the money.

Assuming we have sold a 0.4800 call on the New Zealand dollar (put

on the US dollar). Premium received gives us a cushion, but we should

look to start hedging on a daily close above the upper cloud line.

Once the cushion has been exhausted then these are usually hedged

on a sliding scale based on the delta and the expected vega.

Ichimoku is good for trending markets and predicting turns in the

trend but can it be used in sideways markets? In this example of the

Euro/Swiss franc, we have a market that has been trading broadly

sideways for some time (the rate has traded between 1.4400 and

1.4900 for the whole of the year) and is likely to continue trading in

this way as it is neither above nor below the cloud.

We could sell a straddle (a call and a put with the same expiry and the

same strike) to pick up premium, with the strike at the mean rate of

the period, 1.4650. The option premium received would give us

enough cover to allow for several moves around the central rate. Brief

moves into the money, either the call or the put, are covered by the

option premium received for both the options.

However, based on Ichimoku, I would suggest selling a strangle

instead. Pick a call with a strike above the highest cloud for the period

observed, 1.4950, and put with a strike below the lowest Chikou Span

level, 1.4450. The premium received would be a lot less, but I think

that running the position would be a lot less stressful. Time value will

steadily erode until the option expires worthless. Premium income

equals net gain to grantor. Note that these types of options are used a

lot in the interbank market, and participants will go to great lengths to

protect the options they have sold so as to ensure they expire

worthless.

New Zealand Dollar

Euro/Swiss


Another strategy for a market that is likely to go nowhere over the

next month or so would be a double no touch. Note that as a rule of

thumb, in FX circles, we tend to grant plain vanilla options (simple

basic strategies) in low volatility environments, and exotics (option

strategies with all the ding-dongs) in high volatility situations. This

saves the seller money when the market is flying about as knock outs

are more likely to be triggered, thus making the option worthless.

Anyway, a double no touch means that the options remains alive so

long as neither a pre-established upper or lower level have traded.

The seller of the strategy should chose touch levels that are far

enough away to satisfy the buyer, but preferably inside the cloud or

recent high points/low points. So for Euro/Swiss we could try and sell

a double-no-touch with an upper level at this summers high of 1.4800

and a lower level at 1.4450. With a little luck these levels are likely to

be hit, again killing the option leaving the vendor with the premium

and no position to run or worry about.

Prices are still below a nice fat cloud and the trader thinks they will

hold below here and move lower again. However, the cloud structure

has deteriorated so there is a chance that we might break higher. I

would suggest selling an at-the-money call and buying a second, out-

of-the-money call, for the same expiry. Premium received will be more

than that paid out, making this a good way to work with clouds. The

call you sell will be the one at the bottom of the cloud. The premium

received should be more than enough to cover you until the top of

the cloud, the strike where the second call is bought. The market gets

stuck in the middle; time is wasted and you have made a profit. But, if

the trend really does change, then one for one the option you bought

will cover the losses on the option you granted.

Variations on this idea could include buying twice as many out-of-the-

money calls. This would, of course be more expensive and to be able

to do this the cloud would have to be a lot thicker (and the strike

prices further away from each other). In this case, if the market breaks

higher, then the first call covers the losses on the call that was granted.

The second call makes the money as a speculative position.

Selling a Calendar Spread

Here, instead of using nice fat clouds, we are looking to the point at

which the Senkou Span lines cross. The US dollar against the Swedish

krona, quoted the European way as krona to the dollar. Here we are in

late August and September and the market pushes up against the

cloud and pulls back. The cloud is expected to halt further rallies, but

not forever. The thinness suggests a break higher by November.

Strategy: sell a three week call using the top of the cloud as the strike,

9.5000. This option will hopefully expire worthless as the market will

not have broken higher by then. Timing is obviously key here, with the

choice of strike a secondary issue. Premium received can be used to

fund part of another call at the same strike, or all of a call at a higher

strike. But this second option starts two weeks later and expires two

weeks after the first one. To make it more affordable, it too could have

a knock in (say at 9.1000) before it gets going.

Another idea for a market that has very fat clouds with a thin bit in the

middle, when you anticipate that the market will change direction, is a

box trade. Buy a call at the top of the cloud 9.5000 again. Fund it by

selling a put below Chikou Span 9.1000. The premium on the two

would be roughly equal.

A more complex variation on this idea would be selling a butterfly

spread. For this example I will look at the Euro. The clouds are not as

fat as I would like, but I prefer using current examples. Anyway, we

will sell a 0.9900 call, buy two 1.0000 calls and then sell a 1.0100 call to

help fund this little gem, all for the same maturity. This trade is market

bullish and volatility bullish, with positive delta and gamma. The two

par calls will cover any losses on the first call sold and, with a little luck,

the other call sold will expire before moving into the money.

Most trading revolves around trading bands, trends and timing.

Ichimoku captures all these ideas in a very graphic and immediate

way. But more important, option trading requires even more thought

and attention than outright positioning. All too often investors

become tremendously complacent, buying an option because the risk

is perceived to be lower; happily hanging on to the option, especially if

it is in-the-money, not realising they may now hold an outright

position or an inefficient strategy. Trading is something to be

approached fresh every day, with an open mind and a sensible, flexible

strategy. Every day check the trend and whether the original view is

still right. Check implied volatility and, if it is ridiculously high, consider

selling out the option. Understand whether you want a high or low

delta. Time decay, which accelerates dramatically in the last few days

in the life of an option, can be used to your advantage. Option trading

is not easy but Ichimoku can help enhance your returns.

Nicole Elliott is a technical analyst with Mizuho Corporate Bank inLondon. The banks name may not be familiar to you as it is only ninemonths since it was incorporated. It is the result of the merger betweenthe Industrial Bank of Japan, Fuji Bank and Dai Ichi Kangyo Bank. It isnow the largest bank in the world in terms of assets.

Silver

Euro

Swedish Krona

I have clearly made a mistake in calculating the time zone for a GreatBear Market (GBM) low. I assumed that, since the mania wastechnology-related, the high to use was March 2000, but theSeptember-November 2002 zone only produced GBM-sized declinesin France and Germany, and the overall configuration in the US and UKdid not look convincing. Perhaps more importantly, the indicatorreadings on the October-November recovery did not confirm a newbull market. Furthermore, the FT World Index reconfirmed on thedownside in late January, as Chart 1 illustrates.

If it is not March 2000, then it is September 2000 where calculationsshould start. Apart from the fact that the FT World Index peaked then(FT All-Share and CAC 40 on the 4th and NYSE on the 11th), my Elliottcount for the S&P 500 treats its 31st August high as ending the bullmarket with a failed fifth wave Diagonal Triangle. Extrapolating theGBM time periods from 4th September produces a time range of 6thFebruary 2003 through 6th July. This can be narrowed down further.

In Elliott terms, I believe that an (A)-(B)-(C) pattern has been unfoldingsince September 2000. It is therefore worth looking for a low where(C) equals (A) in time terms. For the NYSE, this is Saturday 29th March -see Chart 2. For the FT World, CAC and UK All-Share indices, it isSaturday 5th April. Broadly, therefore, a low could fall in the last weekof March or the first week of April.

In addition, if you look at a range of indices and Fibonacci ratios, thereis one further cluster of dates worth watching: 26th June to 12th July.

The appearance of this second cluster is interesting for two reasons.Firstly I believe that the decline from the November 2002 high maysub-divide into two downward legs, so if the overall configurationdoes not look right by the end of this month, it may by July. A more

important reason is that, if you look back at the history of globalmarket lows over the past thirty years, it is quite common to seedifferent countries producing final closing lows months apart, as thetable reveals. If indeed a Great Bear Market bottoms this year, it maybe drawn out globally. The table highlights well where September,October and November get their reputations. I am hoping/expectingthat 2003 will be different.


Still a Great Bear Market?By Peter Beuttell

330

300

250

200

150

110

F M A M J J A S O N D J F M A M J J A S O N D J 30%(R.H.SCALE)

Source: DATASTREAM

RSI at 30 with a falling 200-day

average warns of a resumed downtrend.

Chart 1

FT WORLD INDEX & 14-DAY RSI240

200

150

100

50

5

FTSE W WORLD - PRICE INDEX14-DAY RSI(R.H.SCALE)200-DAY M.A.

,

,

*

*

29.03.03

375 days (A)

(B)

375 days

Chart 2

7500

7000

6500

6000

5500

5000

4500

4000

2000 2001 2002 2003

Source: DATASTREAM

NYSE COMPOSITE

110

105

100

95

90

85

80

75

70

US

UK

France

Chart 3

J F M A M J J A S O N D J F M S&P 500 COMPOSITE - PRICE INDEXFTSE ALL SHARE - PRICE INDEXFRANCE CAC 40 - PRICE INDEX Source: DATASTREAM

MARKET COMPARISONS - 1994/95

1974 1987 1990 1994 1998

Dow Jones 06.12.74 19.10.87 11.10.90 04.04.94 31.08.98

S&P 500 03.10.74 04.12.87 11.10.90 04.04.94 31.08.98

UK 13.12.74 10.11.87 24.09.90 24.06.94 05.10.98

France 26.09.74 29.01.88 14.01.91 13.03.95 08.10.98

Germany 07.10.74 10.11.87 28.09.90 28.03.95 08.10.98

Japan 09.10.74 11.11.87 01.10.90 29.06.95 09.10.98

Hong Kong 10.12.74 07.12.87 28.09.90 23.01.95 13.08.98


At the time of putting this issue to press, military action in Iraq seemsincreasingly inevitable. Back in October at the IFTA conference, RalphAcampora had already anticipated this situation and he and Edward Keonhad done some very interesting work on what happened to the DowJones index during previous periods of conflict since the Second WorldWar.

On each of these occasions, the market fell sharply after the incident thattriggered the action occurred but rallied once the riposte got underway.

Ralph Acampora is Director of Technical Analysis and Edward Keon is Directorof Quantitative Research at Prudential Securities.

World War II

Pearl Harbour

September 11th, 2002

Sputnik

Cuban Missile Crisis

Gulf War

The pattern of warBy Ralph Acampora and Edward Keon

Korean War

Documents

Market Technician No 46