Market Technician No39

web site: www.sta-uk.org The Journal of the STA

1

The Societys AGM was held on 15th November and inhis report the Chairman, Adam Sorab, noted that thelast financial year has been a very positive one for theSociety. The depth and range of the Societys activitieshave broadened considerably. Largely thanks to thehard work of our membership secretary, numbers areincreasing steadily and a new system has been set upto manage the database. The number of hits on ourwebsite has also risen sharply and some major newinnovations for the site are currently in the pipeline.

There has been a reasonably good response to the one-day conference being held in Edinburgh this monthwhich is being sponsored by CQG, Reuters and Bank ofScotland. It is hoped to run similar events in other partsof the country over the next 12 months. Looking a littlefurther ahead, the UK has been chosen as the centre forthe October 2002 IFTA conference. This will be a majorevent and planning is already under way. Thecommittee will need to co-opt some additional help andany members prepared to lend a hand in any wayshould contact either Adam Sorab or Anne Whitby.

Education continues to be a core activity for the Societyand 50 students have enrolled on this autumnsfoundation and introductory courses. The diplomacourse will start on 16th January and more details of

this are given on page 11. A launch date for theDistance Learning Course will be announced this year.

As we are now in the 21st century, we do ask that allarticles for publication in the Journal are submittedeither on disk or sent by e-mail. Authors are alsoresponsible for obtaining permission to reproduce anytext, data or chart that is copyrighted by some otherperson or organisation. It is very good to see a numberof new names contributing to this issue of the Journalas well as some of the stalwarts. David Watts, whoheads up the software committee, has done awonderful job of pulling together a list of all theinteresting technical analysis and charting services.There have been frequent requests for this informationin the past from members and we are not aware ofanyone else having produced such a comprehensive list probably because it is an extremely laboriousexercise. We are very grateful to David for havingundertaken it.

COPY DEADLINE FOR THE NEXT ISSUE31 JANUARY 2001

PUBLICATION OF THE NEXT ISSUEMARCH 2001

November 2000 ISSUE No. 39

MARKET TECHNICIAN

FOR YOUR DIARY

IN THIS ISSUE

Wednesday, 6th December 2000 Christmas party

Wednesday, 10th January 2001 Monthly Meeting

Wednesday, 14th February 2001 Monthly Meeting

Wednesday, 14th March 2001 Monthly Meeting

N.B. The monthly meetings will take place at the Institute of Marine Engineers, 80 Coleman Street, London EC2 at 6.00 p.m.

D. Watts Software Review 3

M. Feeny Book reviews 6

A. Collins Using displaced moving averagesin foreign exchange dealing 8

V. Tikhonov Taranalysis New developmentsin market forcasting 10

M. Wignall Open interest, volume and priceanalysis: the special case of marketswith inter-exchange mutual offsetting systems 12

J. Arter Focus on Thailand 16

WHO TO CONTACT ON YOUR COMMITTEE

CHAIRMANAdam Sorab, Deutsche Bank Asset Management, 1 Appold Street, London EC2A 2UU

TREASURERVic Woodhouse. Tel: 020-8810 4500

PROGRAMME ORGANISATIONMark Tennyson dEyncourt. Tel: 020-8995 5998 (eves)

LIBRARY AND LIAISONMichael Feeny. Tel: 020-7786 1322The Barbican Library contains our collection. Michael buysnew books for it where appropriate, any suggestions for newbooks should be made to him.

EDUCATIONJohn Cameron. Tel: 01981-510210Clive Hale. Tel: 01628-471911George MacLean. Tel: 020-7312 7000

IFTAAnne Whitby. Tel: 020-7636 6533

MARKETINGSimon Warren. Tel: 020-7656 2212Kevan Conlon. Tel: 020-7329 6333Tom Nagle. Tel: 020-7337 3787

MEMBERSHIPSimon Warren. Tel: 020-7656 2212Gerry Celaya. Tel: 020-7730 5316Barry Tarr. Tel: 020-7522 3626

REGIONAL CHAPTERSRobert Newgrosh. Tel: 0161-428 1069Murray Gunn. Tel: 0131-245 7885

SECRETARYMark Tennyson dEyncourt. Tel: 020-8995 5998 (eves)

STA JOURNALEditor, Deborah Owen, 108 Barnsbury Road, London N1 0ES

Please keep the articles coming in the success of the Journaldepends on its authors, and we would like to thank all thosewho have supported us with their high standard of work. Theaim is to make the Journal a valuable showcase for membersresearch as well as to inform and entertain readers.

The Society is not responsible for any material published inThe Market Technician and publication of any material orexpression of opinions does not necessarily imply that theSociety agrees with them. The Society is not authorised toconduct investment business and does not provideinvestment advice or recommendations.

Articles are published without responsibility on the part of theSociety, the editor or authors for loss occasioned by anyperson acting or refraining from action as a result of any viewexpressed therein.

One of the aims of the Society is to increase thepublics awareness of technical analysis. We are oftenapproached by academic institutions and the media tosuggest the names of people who would be preparedto speak on the subject or to give their views onmarket action. (They do need to be authorised underthe Financial Services Act). The current policy is not torelease any details of the membership without theirprior permission but we are building up a list of namesof people who would be prepared for their names tobe put forward. Anyone interested in being included inthis contact list (and dont forget it not only helpsspread the word about technical analysis but alsoraises an individuals profile in the market) shouldcontact Katie Abberton.

* * * *

Members have been very slow to submit their e-mailaddresses. We have updated our administrationservice and members will now receive notices andinformation about the Societys activities muchquicker by e-mail.

* * * *

Simon Musselwhites name was omitted from the list ofpasses for the Diploma Examination in April 2000.

2 MARKET TECHNICIAN Issue 39 November 2000

Networking

ANY QUERIES

For any queries about joining the Society, attendingone of the STA courses on technical analysis ortaking the diploma examination, please contact:

STA Administration Services(Katie Abberton)

P.O. Box 2, Skipton BD23 6YH. Tel: 07000 710207 Fax: 07000 710208

www.sta-uk.org

For information about advertising in the journal,please contact:

Deborah Owen

108 Barnsbury Road, London N1 OES. Tel/Fax: 020-7278 7220

Issue 39 November 2000 MARKET TECHNICIAN 3

TECHNICAL ANALYSIS SOFTWARE SURVEY

The variety and sophistication of charting services and technicalanalysis software packages continues to grow. These cover a widespectrum from institutional level services for the professionaltechnician to those available to the general public to track their stockportfolios. In fact the variety is now so large that the technician isfaced with a formidable task of discerning his need, then evaluating awide range of packages. While there continue to be leaders in eachfield, increasingly one charting service or software package can covera whole range of technical chart studies.

In order to make the evaluation task somewhat easier, I haveproduced the following tables with brief comments on the mostpopular packages. The categories are not hard and fast and manyservices cross each category, but the divisions appear reasonable. Thissurvey can only touch upon the main elements of each softwareservice so I have included here those general services and softwarepackages of interest to all, rather than the more specialised packages,which would justify a separate survey. This listing is by no meanscomplete, but may act as a reference to those searching for a newtechnical package or charting service.

It is interesting to note the most recent development in the provisionof charts, is via online INTERNET services. This removes the need forthe chore of data maintenance, while allowing you to access theservice from any terminal. Most professional services now offer avery competitively priced internet product and these are well worthexploring. Many of these Internet services offer free daily charts, anda limited range of technical tools such as moving averages. Whilethese services cannot replace a good analysis package, they do allowa quick check to be made of most commodity or stock charts.

In order to give some guidance to the new technician, it is also usefulto consider what is available at each price level.

Free Web Based Services

Free end-of-day charts are available on the Internet from a variety ofsources. Some provide excellent charts which are more thanadequate for the new technician. While the US services have a lead,the UK is rapidly catching up. Services such as Metastock Online(www.equis.com/java/), www.Bigcharts.com, TFC Commodity Charts(www.tfc-charts.w2d.com) and Commodity Price Charts(www.commodity-price.charts.com) are excellent.

UK Equity services such as those by UKInvest (www.ukinvest.com),and Stockpoint (www.stockPoint.com) are two which offer freeonline charts for the UK equity investor.

Web Based Charting Services

Here, subscription services can provide end-of-day data at modestcost and real time data for the professional technician. Generally thecharts rival that of most software packages with a wide range oftechnical studies and large clear charts. Services such as DBC Signal(www.dbc.com), Quote.com (www.Quote.com), Proquote(www.Proquote.net), ADVFN (www.ADVFN.com) and Nextrend(www.nextrend.com) are all worth investigating.

Software packages

The flexibility, ease of use and wide range of studies result in theneed for stand alone charting packages. The drawback is normallythe time consuming task of database maintenance. Here the generalsoftware package acts as a toolkit and often includes a wide varietyof technical studies. Within this category there is a wealth of choicewith individual preference being the deciding factor. The UK technicalcharting software companies such as Indexia, Synergy and Updata allprovide a range of charting packages to suit all levels of experience.Also they have the advantage of providing local and ongoing supportservices to the user. Equally the US software industry does provide anumber of firm favourites, such as Metastock by Equis, andSMARTrader by Stratagem Software. It is also worth noting thatSMARTrader is the Windows version of the old favourite Dos basedComputrac software, which was, at one time, the choice of manyexperienced technicians.

System Testing

System traders are those who wish to test and trade technical tradingsystems. The technician can utilise these sophisticated testingpackages to back-test his technical theories without the fear of loss.These incorporate a programming language that can be used tomodel a particular set of technical conditions. Here the US packageshave a distinct advantage and Metastock by Equis and Tradestationby Omegasearch are well worth considering.

I also noted that CRB-Bridge (the US data and charting service) offersa commodity system-testing package SystemMaker which at $125appears to be a bargain within this category.

Job Title: TECHNICAL ANALYSTCompany: Premier Research HouseSalary: Competitive

Company:Our client provides screen based commentary via the major vendors to the dealingrooms. They provide recommendations to banks throughout the world who takethe services on a subscription basis. There is a team of 10 technical analysts inLondon, covering FX, bond and stock indices mkts, major and emerging.

Additional to pure Technical commentary there are analysts covering the marketfundamentals economic and political. The client provides a 24-hr service withour Singapore and New York offices. All staff have the STA diploma or a similarTechnical Analysis qualification. Many have come from a dealing roombackground, though not all have actively traded.

Role:The client is looking for a FX/Bond Technical Analyst to provide predominantlyintra-day (but also longer-term) written Technical Analysis of FX/Bond mkts. Toidentify profitable trading situations, not just market direction but also the entrypoints, objectives and stops. Excellent written/oral skills essential, 2 to 3 yearsexperience and STA diploma (or similar) preferred. Dealing room experience anadvantage. Flexible attitude and ability to work within a large global team essential.

10 BEDFORD STREET LONDON WC2E 9HETel: +44 (0)20 7379 333 Direct Tel: +44 (0)20 7915 8739Fax: +44 (0)20 7915 8714Email: [email protected]: www.robertwalters.com

Software ReviewBy David Watts


A specific form of system testing is Pattern Matching for specificbar or candle formations. Pattern matching is offered by such littleknown packages as Patterns and the Windows based Investigator2 amongst others.

Unfortunately most system testing software does not allow portfoliolevel testing of systems which is a major shortfall. There are really onlytwo packages, to my knowledge, that presently offer this type ofanalysis. TechniFilter Plus by RTR Software is a Windows program thatallows you to test a system over a portfolio of stocks or commodities.Trading Recipes by R. W. Systems is a Dos based program with a BasicSystem Programming language that allows you to test almost anysystem across a portfolio of commodities or securities.

Professional Level Services

The mainstream institution level data providers such as Bloomburg,Bridge, Data Stream/ICV, Reuters come into their own here. Eachtends to offer a specialised product to a particular section of thesecurities industry. Reuters has just added its Metastock chartingprogramme to its range of professional services. Commodity QuoteGraphics (CQG) and the Commodity Research Bureau now ownedby Bridge are well established in the US commodity markets. Whatis less well known is that most professional services offer a cut-downservice to the public. DataStream/ICV offers Market-eye(www.Market-eye.com) for UK Equities and Bridge/CQG/Reuters alloffer an excellent Internet based service. Reuters US, for example,offers a self-correcting data service for the US markets via theEquis.com web site.

Technical Analysis Resources

The following tables provide a resource listing for major suppliers oftechnical analysis software. Details of the type of service or technicalanalysis package are listed together with price and contact details.Brief comments are provided as an initial guide and, whereapplicable, the benefits of the package are listed. At the professionallevel, the variety and extent of the services provided do not allow aprice to be stated. Because of this each vendor may be contactedindividually, or further details may be found via their web site.

For the technical analysis software, the tables are divided into sub-sections depending upon the type of package and the majority ofthe software is for the Windows/Dos operating system. Howeverthere is a sub-section for those who use the Macintosh operatingsystem as well.

DEALING ROOM PACKAGES.

TECHNICAL ANALYSIS TOOLBOX SOFTWARE PC

InformationSystem

Web Address PackagesAvailable

Comment

Bloomberg www.bloomberg.com

Various. Primarilyknown for theirsupport to bondtraders.

Mainstream US serviceprovider. Popular withBond desks.

Bridge www.bridge.com

Various. Noted fortheir worldwidemarket coverage.Now integratedwith theCommodityResearch Bureau,see below.

The internet datapackages are excellentvalue for money.

CommodityResearch Bureau-(Bridge USA)

www.crbindex.com

Known for theircommodity chart books.Also provides long-termwall charts. Anestablished EODcommodity dataprovider. Now ownedby Bridge.

CommodityQuote Graphics www.CQG.com

A good TAcharting front end that alsointerfaces a widevariety of TAsoftware.

An established supplierto the commoditytrading community.Known for their timelyand clean data.

Of particularinterest is theirSystemMakerPackage, whichis a powerfultechnical analysisprogram thatcreates, backtests,and optimizesindividuallydesigned tradingsystems.

Price $125.00

InformationSystem

Web Address PackagesAvailable

Comment

Datastream/ICV(PrimarkCorporation)

www.icv.co.uk

Topic and Market-eye Provider.Primarily coversUK equities.Market-eyeintegrates with awide variety oftechnicalsoftware.

Provides Stockbrokerinformation via Topic,Market-eye real-timeinformation to the public.

Reuters www.reuters.comwww.reutersdatalink.com

Now withMetastockProfessional as afront end TApackage.

Long established as apremier provider to theForex Market. The USservice Reuters datalinkoffers a range of NorthAmerican data packages.

TechnicalPackage

Web Address Packages Comment

AIQ SystemsTel:001-800-332-2999

www.aiqstyems.com/UK email:[email protected]

TradingExpert Pro$1295TradingExpert EOD$695

Monthly plansavailable from: $59for delayed data or$79 for RT(+exchange fees)both an internet datafeed that interfaceswith Track Datapackage, Mytrack.

A highly regardedpackage for the EquityMarkets. Extensivesector analysis can beperformed. With theproprietary experttrading system.

UK Support available.

EquisInternational.Tel: 001 800 882 3040

www.equis.com

MetastockProfessional foreSignal $1495

Metastock Pro. forReuters.Introductory pricingUS of $195 Per month.

Metastock $399

MetaStock Online Free

Downloader Free

Metastock, is a long time favourite withtechnicians due to thewindows interface andwide range of TA studies.

Able to test simpletechnical systems.

Do not miss Metastockonline for free USequity charts.

US support only.

INDEXIATel: 01442 878015 www.indexia.com

INDEXIA Intro end-of-day 79.95

INDEXIA II end-of-day 410.08

INDEXIA II Plus end-of-day 910.63

INDEXIA Intro real-time 616.88

INDEXIA II real-time 793.13.75

INDEXIA II Plusreal-time 1233.75

OptionTrader 170.38

Indexia provides a widerange of TA packagesfor every pocket. Anestablished UK softwarehouse that provides awide range of studiesplus the excellentproprietary IndexiaFilters.

With a knowledgeableand professional UKSupport Service.

Omega researchTel: 001 800 793 0144or001 305 485 7400

www.omegaresearch.comwww.tradestation.com

Tradestation$2399.40

RadarScreen$2399.40

OptionStation$2399.40

Now with a webbased service atTradestation.comwhich, once approved,will provide onlinedealing of yourprogrammed systems.

Tradestation is theoriginal real-time systemtesting package, thatused easy language forprogramming systems.Initial releases tend tobe buggy and the singleprecision data handlingcan cause programmingproblems. But still afavourite with systemtraders.

US Support.

AGETTel: 330 645 0077

www.tradingtech.com

Advanced GET$2,750

Advanced GET RT$2,520 for a one yearlease

A highly regardedpackage due to its easeof use, with one clicktrendlines. Providesindicative Elliot Wavecounts and Gann Boxes.

US support only.

StratagemSoftware IntlTel: 001(504)885-7353

www.members.aol.com/stratagem1/main.htm

Quickcharts($99.00),

SMARTrader($299.00),

SMARTrader RT($995.00)

SMARTrader is a must forexisting Computrac users.

This is the follow oncompany where theComputracprogrammers went tocreate a Computrac forWindows. It has all thestandard Computracindicators plus more.

US Support.

TECHNICAL ANALYSIS TOOLBOX SOFTWAREMAC. OS

PATTERN MATCHING SOFTWARE

PORTFOLIO LEVEL SYSTEM TESTING

INTERNET BASED CHARTING SERVICES


TechnicalPackage


UpdataTel:020 8874 4747

www.updata.co.uk

Updata Trader ProFirst Year 1909+VAT(Real-Time)

Fairshares Portfolio Pro1218+VAT.

Updata Invest49+VAT. (off line)

Fairshares Monitoringand Selection only99+VAT.

Both EOD and Realtimepackages available forequity charts. Anincreasingly popularservice to the privateinvestor. Now owns theFairshares TApackage.

UK support.

WaveWise MarketSpreadsheet. Tel:001 908-369-7503

www.members.aol.com/jtiware/

Waverwise costs$299.00

A spreadsheet interfaceand good charts makethis a flexible datahandling and chartingpackage. For thespreadsheet lover.

TechnicalPackage


Investor RTChartingTel: 001 800 546-6842or001 404 733-5733

www.linnsoft.com

Investor/RT$995

Cross platform TApackage with extensiveStudies.

US support.

ProTA by BeesoftTel:001 847 854-3960

www.beesoft.net

ProTA$59

ProTA Gold$199

Extensive studies for acompetitive price. Witha wide range of dataformats supportedincluding, Metastock

US Support.

TrendsetterAnalyst Tel:001 714 547-5005

www.Trendsoft.com/

Analyst Lite$159

Personal Analyst$329

Personal Hotline$595

Pro Analyst $495

An extensive range ofSoftware. The Pro-Analyst packageIncludes a Day-tradingPivot based tradingsystem.

US Support.

TechnicalPackage


Pattern Smasher www.kasanjianresearch.com

Pattern Smasher$2,195

Pattern Smasher cantest and scan for pre-defined bar patterns.Has a wide range ofpre-programmedpatterns such as doubletops and bottoms.

US support and ongoingNewsletters.

Patterns

Patterns$429

The updated Nava-Patterns program. Dosbased. Able to test bar bybar and candle patterns.

US support.

Investigator 2 www.great-trades.com

Investigator 2$495.00

Windows based PatternMatching product. Ableto test bar by bar andcandle patterns.

US support.

TechnicalPackage


Trading RecipesTel: 410 263 0798 None

Trading Recipes$2,495.00

R W Systems Address:5757 Westheimer,Houston, TX 77057. It may be Dos but thereis little to rival theflexibility of thispackage in terms oftesting systems on aportfolio. Basic typelanguage.

US support.

TechniFilter PlusTel: 919 856 9600 www.rtrsoftware.com

TechniFilter PlusV.8$425.00

TechniFilter is areporting and system-testing package forWindows but with onlybasic charting. Excellentfast scanning.

A comprehensive,proprietary systemtesting language thattakes some time to learnbut does allow portfoliolevel testing.

Web based supportonly.

TechnicalPackage


AdvancedFinancial Network www.adfn.com

Unlimited freereal time prices.

Level 2 Data isfrom 35+VATper month.

A rival to Quote.comfor UK Equity quotes.

BigCharts www.Bigcharts.com

Interactive chartsand quotes.BigCharts is aFREE service.

A provider of charts tomany other internetsites. UK share chartsavailable.

www.marketsonline.com/investment-software.htm

Mytrack www.mytrack.com

Delayed quotesare free for bothUK and USEquities

Mytrack provides aspreadsheet typeinterface to a quotetable.

Basic charts available orit can interface to theAIQ charting package.

NexTrend www.nextrend.com

NexTrend Trader Free

Nextrend TraderPlus From$79.95 a month

A new service that haspromise. Wide range ofTA studies and charts.

US Securities andFutures data only.

Qcharts byQuote.com

www.quote.com/quotecom/qcharts/

RT and Eod dataservice. With anexcellent chartinginterface. $79.95per month plusexchange fees.

A premier internetcharting service for theUS commodity andStock markets.

If they provided Europeanquotes Quote.comwould be a seriouscompetitor to most UKprofessional services.

MarketSmart byPcquote.com

www.Pcquote.com

MarketSmartprovides real-time quotes plusEOD charts for$9.95 a monthplus exchangefees.

Hyperfeed Technologiesdata transfer technologyfor fast internet access.This internet data feed,interfaces with a varietyof real-time packagesincluding Excel.

MarketSmart providesEOD charts only.

US Securities.

Proquote.com www.proquote.comProquote ServiceFees from 39.00per month(+VAT)

Equity based quotes andcharts. New.

SiliconinvestorIQcharts

www.iqchart.com/iqchart/

From $35/monthincludingexchange fees.

IQ ChartDelayed Data$24.95/month.

Excellent charts and thecompetitive cost makethis a great chart servicefor US stocks.

StockPoint www.stockpoint.com

Free Stock bar andcandle charts withIndicators andmoving averages.

Excellent source ofequity charts coveringmost exchangesincluding the UK.

Synergy SoftwareTel:01582 424 282 www.synsoft.co.uk

For the Professionaland Dealing room:Sequencer and RITA

For the PrivateInvestor:

Portfolio Evolution144 + VAT per annum

Portfolio Advantage

336.17 + VAT perannum

Portfolio DayTrader(Real-time)890+VAT plusExchange Fees Plusdecoder box155+VAT

Offers a wide range ofpackages to monitorand chart securities. The current investorpackages have anintegrated datapackage. The ease ofRelative Strengthcharting has alwaysbeen a strength of theSynergy softwarepackages.

UK Support.


IRRATIONAL EXUBERANCEBy Robert J. Shiller (Princeton University Press $27.95)

The field of behavioural finance is increasingly important today, as itis becoming difficult to explain current stock market behaviour usingconventional financial theory.

Robert Shiller of the Cowles Foundation, University of Yale, bases thetitle of his book on the famous phrase first used by Federal ReserveBoard chairman Alan Greenspan in December 1996.

These very words caused, the following day, a precipitous drop instock market prices all over the world.

Andrea Caggese, a researcher in the Financial Markets Group of theLondon School of Economics, reviews the Shiller argument aboutmarket over-valuations:

Shiller argued that this drop was more than a reaction to strongerexpectations of tighter U.S. monetary policy. Many investors wereworried and shared the view that the markets were irrational.

Something similar, in Shillers view, happened during the stock marketcrash in 1987. On that occasion, Shiller had the opportunity to senda questionnaire to professional investors about the reasons of thecrash, just one week after the event.

The conclusions drawn from the analysis of more than 1000responses were quite surprising: there was no reaction to real newsbehind the massive sell-off shares. Investors often mentioned theover-valuation of the market and investor irrationality, but they didnot justify the crash using any real economic news. Hence, Shillerargued that the crash was generated by a feedback loop. After a firstprice decline investors sold, not based on fundamentals, but becausethey were worried about what was going on and about marketirrationality. The drop did not stop until enough people started tohave opposing feelings.

Shiller argued that the current high level of the stock market is largelydue to a positive feedback loop, and his book aimed at a completeand formal treatment of the irrational exuberance phenomenon.

His first step was to put recent stock market values in an historicalperspective, and to show that actual levels are exceptionally highwith respect to all conventional measures. The US Standard & Poorindex (Figure 1), adjusted for inflation and available from 1871 to2000, has increased by three times in the last five years. An equallybig increase only happened just prior to the 1929 stock market crash.Stock indices in other major economies, aside from Japan, have alsoexperienced similar rises.

Inflation corrected earnings also are above historical levels, to a muchsmaller extent. As a consequence the ratio of prices to the average ofpast 10 years earnings has become exceptionally high. The lessonfrom this historical analysis is very clear: the US stock market, as wellas stock markets in other developed economies, is overvalued.Moreover past data show that the market has always performed verypoorly in the years following such high levels, confining the view thatthe random walk hypothesis is not a good approximation for long-run price behaviour.

Shiller then turned to the structural factors behind such over-valuation. His view was that the current situation has been caused bya unique confluence of many precipitating factors, plus a series ofamplification mechanisms.

He agreed that the development of the Internet and the World WideWeb constituted major technological advances, but also he pointedout an important psychological factor: as opposed to past majortechnological progress, the World Wide Web is an everydayexperience for all of us. Hence Shiller argued that some of theincreases in earnings since 1994, probably due to the recovery fromthe early nineties recession, were instead mistaken for the effects ofthe diffusion of the Internet.

Another precipitating factor is the baby boom that occurred after theSecond World War. Baby boomers are now progressively retiring andinvesting in stocks.

Shiller then turned to the most interesting aspect in understandingmarkets behaviour: the emphasis on cultural and psychologicalamplification mechanisms. Regarding cultural factors, the MassMedia has had a large role in building the so-called new erathinking. The new era theory has been pushed as a way to build anexciting story and to grab the attention of the public. As aconsequence everybodys attention has turned to stock markets, andthe new era thinking has greatly increased the optimism towardsfuture unbounded stock market growth.

Regarding psychological factors, Shiller mentioned the limitations tohuman rationality and judgements, drawing from the results ofpsychology experiments. He asserted that the main amplificationfactor is that positive past results build overconfidence. Thisgenerates the widespread anticipation that every drop in the stockmarket will be reversed and that the market will be up again. In aquestionnaire sent to high-income investors in 1999, Shiller askedseveral questions about expectations. 91% of those surveyeddeclared that in the event of another stock market crash, like in1987, market prices would recover entirely in no more than twoyears. This once again contradicts the random walk hypothesis.

Such a contradiction is also clear from the next question: 59% ofthose interviewed said that, if the stock market dropped by 3%, theywould expect a rise the day after, while only 19% would expect afurther drop. The overconfidence effect is revealed by the fact thatthe same question, asked in 1989 generated an equal number ofpositive and negative answers.

As a result of this overconfidence, 96% of those interviewed thoughtthat the stock market was the best investment for long term holders,thus ignoring all other traditional forms of long term investment, likereal estate.

In Shillers opinion this overconfidence is unmotivated optimism.Investors have convinced themselves that the market will go up, butif questioned they are not able to motivate their expectations in anyrational way.

The conclusion Shiller drew from this analysis is that stock marketovervaluation should be taken very seriously. The level of thestock market is an important issue, and affects not only theeconomy but also society at large, in that it may distort agentsdecision-making processes. For example, today more and morepeople focus on stock market gains and care less about othersources of income and, more importantly, about their humancapital. Also saving is reduced and people care less about socialinsurance.

Shiller concluded that people should rely less on the stock market asa secured source of income, and governments should encouragemore savings and social security.

This review by Andrea Caggese first appeared in FMG Review,Financial Markets Group, London School of Economics, July 2000 pp. 1-2, 9, and is reproduced by permission.

Book Reviews

Figure 1: US Standard & Poors Real Stock Price Index 1871-2000and US P/E ratios 1881-2000

Source: Schiller (2000)


Both Irrational Exuberance and the counter argument attackingthe very notion of the frothy market bubble, Peter GarbersFamous First Bubbles: The Fundamentals of Early Manias, haverecently been acquired by the STA Library, where they will taketheir place alongside those ancient classics by Gustave Lebon andCharles Mackay. The Crowd and Extraordinary PopularDelusions and the Madness of Crowds.

(M. Feeny)

ENCYCLOPEDIA OF CHART PATTERNBy Thomas N. Bulkowski, (John Wiley & Sons, New York 2000. 672 pages)

We should all thank Thomas N. Bulkowski profusely. Better yet, weshould run out to buy Bulkowskis Encyclopedia of Chart Patterns. Thisbook offers hard data that can win credibility for Technical Analysis.

In a totally astounding display of data-handling prowess, Bulkowskihas shown that the classic Chart Patterns we all know and love workfar better than we might have imagined even on a good day. Inextensive computer testing, he found that most Chart Patterns weremore than 80% accurate in calling the next significant move, withquite a few recording a 90% to 100% winning percentage!

Bulkowski selected 500 representative common stocks, each of whichhad five years of accurate daily price data ranging from mid 1991 tomid 1996. Combined, this added to 2,500 years of stock price data.Applying his senior software engineer skills, Bulkowski analyzed wellover 15,000 formations, and he found 67 patterns of significance.

Bulkowski found that the reliability of the patterns was substantiallybetter if trades were executed on the confirming directional breakoutfrom the patterns, rather than in anticipation of a breakout. That isbecause many of the patterns can function as both consolidationsand reversals of trends, and guessing the direction before theconfirming breakout results in a significantly lower winningpercentage of trades. The following tables, derived from Bulkowskispublished statistics, list the most reliable bullish and bearish patterns,in rank order of their winning percentage. The results are skewed tothe bullish side, of course, reflecting the dominant trend of the stockmarket over the period studied.

Win% Rise% Bullish Continuation Patterns

(Must Be Confirmed by Upside Breakout)

98 52 Rectangle, Continuation

98 44 Ascending Triangle, Continuation

98 43 Falling Wedge, (1-3 Month CountertrendDecline), Continuation

96 34 Broadening, Continuation

95 37 Symmetrical Triangle, Continuation

95 54 Rounding U Six-Month Consolidation,Continuation

94 32 Broadening, Right-Angled and Ascending,Continuation (rare)

94 41 Rounded Inverted U Six-MonthConsolidation, Continuation

90 38 Cup with Handle, Continuation

89 37 Horn, Bottom, Consolidation (Three Weekly Bars, Spikes On Each End)

87 19 Flag, Continuation

83 63 Flag, High and Tight, Continuation

81 27 Broadening, Right-Angled and Descending,Continuation

81 21 Pennant, Continuation

75 32 Outside Day, Continuation

75 33 Scallop, Ascending, Six-Month Continuation, (J Pattern)

63 46 Broadening Descending Wedge, Continuation

88 38 Averages

Win% Rise% Bullish Reversal Patterns(Must Be Confirmed by Upside Breakout)

100 46 Rectangle Bottom, Reversal

98 25 Broadening Bottom, Reversal

97 20 Symmetrical Triangle, Reversal

97 40 Double Bottom, Reversal

96 38 Triple Bottom, Reversal

95 38 Head-and-Shoulders Bottom, Reversal

94 37 Complex Head-and-Shoulders Bottom, Reversal

91 37 Bump-and-Run Bottom, Reversal

88 47 Pipe Bottom, Reversal (Pipe is Two AdjacentWeekly Spikes)

87 35 Diamond Bottom, Reversal

83 34 Island Reversal Bottom, Reversal

83 26 One-Day Reversal Bottom, Reversal

77 68 Measured Move (up and down, up), Reversal

91 38 Averages

Win % Drop% Bearish Continuation Patterns(Must Be Confirmed by Downside Breakout)

98 19 Symmetrical Triangle, Continuation

97 24 Scallop, Descending, Six-Month Continuation(Inverted J Pattern)

96 19 Descending Triangle, Continuation

96 19 Rectangle, Continuation

94 19 Rising Wedge (1-3 Month CountertrendRally), Continuation

94 27 Broadening, Continuation

90 15 Dead-Cat Bounce, Continuation

88 15 Flag, Continuation

66 17 Pennant, Continuation

58 17 Outside Day, Consolidation

88 19 Averages

Win % Drop% Bearish Reversal Patterns(Must Be Confirmed by Downside Breakout)

100 20 Rectangle Top, Reversal

97 19 Broadening, Right-Angled and Descending,Reversal

96 23 Broadening Top, Reversal

94 20 Symmetrical Triangle, Reversal

94 20 Broadening Ascending Wedge, Reversal

93 23 Head-and-Shoulders Top, Reversal

92 27 Complex Head-and-Shoulders Top, Reversal

91 18 Broadening, Right-Angled and Ascending,Reversal

87 21 Island Reversal Top, Reversal

85 21 Triple Top, Reversal

84 21 Horn Top, Reversal (Three Weekly Bars,Spikes On Each End)

83 20 Double Top, Reversal

82 21 Pipe Top, Reversal (Pipe is Two AdjacentWeekly Spikes)

81 24 Bump-and-Run Top, Reversal

78 36 Measured Move (down, up, down), Reversal

76 19 One-Day Reversal Top, Reversal

75 21 Diamond Top, Reversal

59 24 Broadening Descending Wedge, Reversal

86 22 Averages

by Robert W. Colby, CMTThis article was first published in the MTAs Journal.


The Displaced Moving Average is a type of moving average (M.A.)that is generally neglected. Almost all M.As annotated on charts areof the simple kind, some are weighted and you even see theoccasional exponential but to see a displaced moving average isexceptionally rare.

Simple; A total of the relevant data is divided by the numberof observations. Therefore each piece of data has thesame percentage weighting.

Weighted; Extra weighting is given to the most recent data. In thecase of a 13 period moving average, the last piece ofdata is multiplied by 13, the second to last multiplied by12, the third last by 11 etc. The final figure is thendivided by the total of the multipliers. (In this case 91).

Exponential; This is another, but complex, form of weighted average,with the difference being that every price is taken intoaccount but with geometric progression the older priceis given less and less relevance. The first price will neverdisappear but its weighting will continually shrink. (Notto be attempted without a computer).

Like many others I have used moving averages to determine trendsfor some time and use a closing price crossover as a means ofentering a fresh position. This, on the whole, has proved to be agood indicator but is prone to bouts of painful whipping when thecurrency pair is trendless. Experimenting with different period movingaverages (based on Fibonacci numbers) to try to eliminate thosewhips showed no significant improvement in the success rate.

It was then that I came across an article dating back to 1992 inwhich Joe DiNapoli talked about his work with displaced movingaverages. As soon as I read, My research showed that displacing themoving averages tended to substantially reduce the whipsaws whiletightly containing the trend. I knew that this was something I had topursue. Fortunately the software I use was able to adapt to the newconstraints easily.

Lets look at a practical example; EUR/USD during last year.

It is immediately apparent that the moving averages on the first threecharts have a remarkably similar look. The main sell signal, given inOctober 1999, that foresaw the major downward move was seen byall four moving averages almost simultaneously (22/10 & 27/10).Simple, Weighted and Exponential, the differences are minimal. Thefourth chart has the Displaced M.A on it and you can plainly see thatoccurrences of closing price crossovers during trends are much less,but the trend is still captured. During periods of range trading thecrossovers are less than the Weighted and Exponential and no morethan the Simple. Lets look at it in a slightly different format.

As you can see there is a markeddifference between the amount ofsignals given by the Simple andDisplaced and those given by theWeighted and Exponential. Clearlythe whipping seen in the lattertwo will severely reduce theprofitability, even in theentrenched trend which thiscurrency pair was experiencing.

six out of the 8 crossover signals given when using the Displaced M.Awere seen in the sideways trading during September 1999. Once thetrend had started, the whole move was unthreatened until June 2000.Contrast that with the Simple M.A that was broken during Januaryand February 2000. That whipping would have reduced profits.

The moving average used in this example is 55 days, and whendisplaced it is by 13 days. These numbers, as I said earlier, werearrived at by a process of experimentation over a period of time witha clear emphasis on Fibonacci numbers. The key in this optimisationwas not to arrive at optimal1 numbers for each currency pair but toarrive at a set that worked over a wide range of currencies, and timeperiods, on a consistent basis. One that could be continually used

Using Displaced Moving Averages in ForeignExchange Dealing

By Alan Collins, MSTA

Simple M.A.

Weighted M.A.

Exponential M.A.

Displaced M.A.

EUR/USD Crossovers

Simple 9

Weighted 12

Exponential 16

Displaced 8

EUR LAST-Daily 07/11/2000 C-.9554 Mov Avg 1 line .9389

Created with Dow Jones TradeStation 1997

EUR LAST-Daily 07/11/2000 C-.9552 Mov Avg - Exponential .9439


EUR LAST-Daily 07/11/2000 C-.9553 Mov Avg - Displaced .9313


EUR LAST-Daily 07/11/2000 C-.9552 Mov Avg - Weighted .9415


1That method would involve almost daily revision, involves changesduring different market conditions and would be unlikely to get therespect of a market trader.


without constant revision. Remember that this forms a method ofpractical trading. It is not a theoretical exercise.

This style of Moving Average is not restricted to daily charts. I applyit to weekly, hourly and even 15-minute charts.

The entry signal came a little earlier in time on the Simple M.A chartalthough not much lower in actual price. The problem was at thelatter stage of the time period when there was a period of 5 hourswhen the uptrend was threatened, at least on that Simple chart.When the Displaced Moving Average is applied that same uptrend istotally unbroken and the profits are therefore undisturbed.

Again with this 15 minute chart you can clearly see that the chartshowing the Simple M.A on the left has earlier but less reliablesignals than the Displaced M.A shown on the right hand chart.

I hope Ive shown that this style of Moving Average is (unfairly)undervalued. Perhaps more of you will experiment with the conceptand discover its advantages.

Alan Collins is Senior Technical Analyst, MCM (Europe) Ltd.

EUR/JPY Hourly Chart with Simple 55 Hour Moving Average

EUR/JPY Hourly Chart with Simple 55 Hour displaced by 13 Hours Moving Average

GBP/USD 15 min Chart with Simple 55 Quarter Moving Average

GBP/USD 15 min Chart with Displaced 55 Quarter Moving Average

EUR/JPY Last 60 min 07/25/2000 C-102.65 Mov Avg 1 line 101.75


EUR/JPY Last 60 min 07/25/2000 C-102.63 Mov Avg Displaced 101.18


GBP Last-15 min 07/25/2000 C-1.5171 Mov Avg 1 line 1.5153


GBP Last-15 min 07/25/2000 C-1.5174 Mov Avg - Displaced 1.5150


Academic doublespeakAnyone considering submitting an article to theJournal might enjoy the following thoughts from theformer managing editor of a research publication.

The phrases below abound in Ph.D dissertations andacademic papers, (their real meanings are written belowthem in parentheses):

It has long been known(I didnt look up the original reference.)

A definite trend is evident(This data is practically meaningless.)

While it has not been possible to provide definite answersto these questions(An unsuccessful study but I still hope to get it published.)

Three of the groups were chosen for detailed study.(The results of the other groups didnt make any sense.)

Typical results are shown.(This is the prettiest graph.)

In my experience(Once.)

In case after case(Twice.)

In a series of cases(Thrice.)

It is believed that(I think.)

It is generally believed that(A couple of others think so, too.)

Correct within an order of magnitude.(Wrong.)

According to statistical analysis(Rumour has it.)

A statistically oriented projection of the significance ofthese findings(A wild guess.)

A careful analysis of obtainable data(Three pages of notes were obliterated when I knocked overa glass of water.)

It is clear that much additional work will be requiredbefore a complete understanding of this phenomenonoccurs.(I dont understand it.)

After additional study by my colleagues(Thy dont understand it either.)

Thanks are due to Joe Boltz for assistance with this studyand to Cindy Adams for valuable discussions.(Mr. Blotz did the work and Ms. Adams explained to mewhat it meant.)

A highly significant area for exploratory study(A totally useless topic selected by my committee.)

It is hoped that this study will stimulate furtherinvestigation in this field.(I personally have had it with this nonsense. Im looking fora new job!)


This article forms the first in a series which will describe a newmethod of stock market forecasting which I have developed. Themethod is based on advanced time series analysis, and recentachievements in this area show that many types of applied taskscan be solved if proper use is made of the available data. Thisyears volatility and the severe decline by the NASDAQ index (tobe the subject of a later article) certainly highlight the need ofboth financial institutions and private investors for improvementsin analytical methods.

Fluctuations in stock prices are reflected by market indices andindicators, but the mathematical process behind their informationis not well enough understood. The derivation of effective marketforecasts is a stochastic process, governed by the laws ofprobability, and is therefore a problem for mathematical statistics.However, these scientific methods are rarely used and, when theyare, they employ only classical statistics. This fails to provide stableestimations of statistical characteristics, and consequently producesless reliable forecasts.

Recent developments in the theory of stochastic processes haveallowed me to create a more reliable approach. It has a soundmathematical basis but, at the same time it is simple to use andinterpret. I believe that it goes a long way to solving previoustheoretical problems surrounding the development of earlierforecasting methods.

Even with methods which provide a fair degree of confidence,there is always the likelihood that in some situations they will fail.This is a fact of life when analysing casual events, and the investoror trader needs to be aware of the advantages (and shortcomings)of the methods which they employ.

The advantages of my new method are:1. The indicators work in practically all market situations.2. They work as both trend indicators as well as providing buy

and sell signals at turning points. In addition they can provide early warning of turning points and subsequentconfirmation.

3. The different components of this method supplement eachother.

4. Its strict mathematical derivation avoids the pitfalls of otherintuitive, heuristic or empirically derived methods.

However, no forecasting method is perfect, and, like the majorityof techniques, volatile markets are more difficult to forecast. I havefound that the results from using short-term cycles (10 days orless) are slightly less reliable than from intermediate (10-30 days)and long cycles (greater than 30 days). Despite this, you will seefrom the later example, using the S&P 500, that my method dealtquite well with the volatile markets of the first half of 2000.

The methods essence is an algorithm, which continuously tests forthe continuation or termination of a trend or cycle within the data.The software package that I have developed employs StochasticProcess Filtering Theory to calculate a mathematical function,which acts as a trend indicator. This function is calculated overnumerous time intervals to provide the probability of a turningpoint during the current trading period. As a price trend advancesthe turning probability also trends, achieving maximum value atthe point at which the price turns, thus providing a coincident-typeindicator.

The software package also calculates the velocity or rate-of-change of the probability function. In mathematical terms, thisrate-of-change of the function at any point is provided by its

derivative, being the difference between the current and previousvalue of the function.

One of the strongest trend continuation signals is the advance (ordecline) of the turning probability function, with itsvelocity/derivative well above (or below) zero. Trend termination ismarked by several features. The most important are that thefunctions angle of ascent/descent lessens prior to its turning signal, and that the velocity/derivative crosses the zero line as thetrend terminates and reverses direction. An early warning signalcomes from the derivative making a top or bottom prior to crossing zero.

The swings in the S&P 500 Index in February through April 2000provide an opportunity to illustrate these features using theintermediate time frame of a 17-day cycle. Figure 1a shows howthe probability functions turned as the index bottomed. Figure 1bshows the velocity/derivative of these functions. By February 21stthe derivatives had already begun to uptrend prior to the marketsturn, and the day of low on February 25th produced a higher low(bullish divergence in chart analysis terms). The bottom-turningbuy signal (Fig 1b) was given on February 29th as the derivativecrossed zero. Despite the short-term index corrections whichfollowed in early March, the uptrend in the probability functioncontinued to strengthen (Fig. 1a), adding confidence that the S&Pwould also continue its advance.

Figure 1a: The turning probabilities that were calculated for 17-day

cycles: 1 on 02.24.2000, 2 on 02.29.2000, 3 on 03.13.2000.

Figure 1b: The velocities of turning probabilities that were calculated for 7-day cycles: 1 on 02.24.2000, 2 on 02.29.2000, 3 on03.13.2000.

Long term probability functions had already signalled that the

Taranalysis New Developments in MarketForecasting

By Dr. V. A. Tikhonov

Fig. 1a

Fig. 1b

Turning Probabilities (Daily)

Velocity (Daily)

markets trend was weak, so the downturn in the derivative onMarch the 24th (fig. 2b) and subsequent rolling over of theintermediate functions (fig. 2a) was not unexpected. (Anintermediate top turning signal for the NASDAQ had already beengiven on March 14th). The imminent turning signal was alsobecoming stronger because the velocity/derivative was fastapproaching zero. The intermediate top turning signal appearedwith the close on March 29th.

On a closing basis, these signals captured 142 points of a 194-point advance, and correctly identified the imminent decline,which carried off a further 150 points after the signal was given,into a mid-April low.

Figure 2a: The turning probabilities that were calculated for 17-day

cycles: 1 on 03.23.2000, 2 on 03.27.2000, 3 on 03.29.2000, 4 on

04.03.2000.

Figure 2b: The velocities of turning probabilities that were calculated for

17-day cycles: 1 on 03.23.2000, 2 on 03.27.2000, 3 on 03.29.2000,

4 on 04.03.2000.

I have checked that my method works on historical data forindices, stocks, bonds, currencies, oil and gold, and I havepublished its results in real time to an e-mail audience, includingthe S&P signals discussed above. These real-time forecasts wereinstrumental in persuading Peter Beuttell of MTS Research Limitedto assist me in producing a forecasting service based on what wehave called Taranalysis, and the creation of our websiteTaranalysis.com. The results of my research will also be publishedin a book soon to be translated into English.

Future articles will cover NASDAQ and the Japanese marketamongst others. Another topic I will cover is the ability ofTaranalysis to determine cycle periods and make forecasts usingmost time series data. Using this technique, I checked theeconomic data used by Nicholay Kondratieff in his cycle analysis.Interestingly, his hypothesis about the existence of long waves of54-year periodicity was not confirmed.

Dr. Tikhonov is Professor of Radioelectronics at Kharkov StateUniversity, Ukraine. The name Taranalysis is derived from hisscientific nom de plume, Dr. V. A. Taran. e-mail: [email protected]


Fig. 2a

Fig. 2bVelocity (Daily)

Turning Probabilities (Daily)

SOCIETY OF TECHNICAL ANALYSTS LTDCOURSES AT SOUTH BANK UNIVERSITY

For the sixth year running, the Society of Technical Analysts Ltd(STA) Education Committee is holding its Diploma course inTechnical Analysis at the South Bank University.

Technical analysis has become an important part of mostinvestment house activity. The courses are considered suitable forthe annual PIA Continuous Professional Department Programme.

The following course is available:

STA Diploma Course 16 January 27 March 2001

Preparation for the Diploma examination on 27 April 2001. The course runs for 11 Tuesday evenings.

Provisional Programme

DATE TOPIC

16 Jan Introduction to the course risk of ruin the role andtypes of analysis comparison basic charts line, bar,candlestick and point & figure (Syllabus Topics 1, 3 and 4).

23 Jan Demand and supply support and resistance trendand trendlines pattern recognition price objectives(Syllabus Topics 1, 6, 7, 8, 9 and 11).

30 Jan Point and figure construction scale reversal criteria objective counting advantages and disadvantages(Syllabus Topics 4, 9 and 10).

6 Feb Candlesticks charts patterns psychology (SyllabusTopics 3 and 9).

13 Feb Moving averages types positioning crossovers envelopes Bollinger bands (Syllabus Topic 2).

20 Feb Momentum momentum indicators oscillators(Syllabus Topics 16,17, 18 and 19).

27 Feb Market Profile [TM] (Syllabus Topic 21).

6 Mar Dow theory breadth indicators investor psychology sentiment indicators contrary opinion (SyllabusTopics 5, 9, 20 and 22).

13 Mar Cycles amplitude and phase harmonicity andsynchronicity translation application (Syllabus Topics15 and 5).

20 Mar Elliott wave theory pattern, time and ratio model Fibonacci applications (Syllabus Topics 13, 14 and 10).

27 Mar Gann theory and application (Syllabus Topics 12and 10).

10 Apr Revision Day including Report Writing.

27 Apr Diploma Exam (3 hours).

The course is held from 6.00pm - 9.00pm in the Castle LectureTheatre within the Abbey Conference Centre at the South BankUniversitys London Road building (a short walk from the Elephant& Castle underground station).

COST: 1250The fees covers the 11 weekly sessions, Revision Day, The Diploma Examand Membership of the Society of Technical Analysts between 1st January2001 31st March 2002.

STA Administrative Services, PO Box 2, Skipton BD23 6YH.Tel: 07000 710207 Fax: 0700 710 208

Email: [email protected]

NOTE: There is a 150 Discount for those students not wishing to attend the RevisionDay and 225 Discount for those students not wishing to sit the Diploma Exam.Anyone opting out of the Revision Day and/or Diploma Exam who later decides toparticipate will be charged an additional premium of 50 (ie. late Revision Daybooking will be charged at 200, Diploma Exam at 275).

It will be possible for STA members to attend individual sessions if they wish.Application (with payment) must be received by STA Administrative Services AT LEAST24 hours in advance of the session. The charge will be 80 per session.

Part 1 Internal Dynamics Of ConventionalNon-MOS Markets

INTRODUCTION

One aspect of the conventional wisdom relating to the analysis offutures open interest, volume and price (OIV&P), which apparentlygoes un-noticed, is that it only relates to contracts that trade on asingle exchange. This appears to have gone unremarked until Wignall(2000) in a previous issue of the Market Technician brieflyhighlighted the fact that contracts that traded on two exchanges andwhich could be transferred between them through Mutual OffsettingSystems (MOS) could create complications for conventional OIV&Panalysis.

SCOPE

This paper expands on that earlier discussion by exploring theimplications for analysts of the MOS between the ChicagoMercantile Exchange (CME) and the Singapore Exchange (SGX) ingreater detail. It could well be sub-titled An exploration of thetyranny of dynamic symmetry and some consequences. It beginswith a reminder of the conventional wisdom regarding the formationof open interest, and its relationship with volume in terms of theappearance of price changes in relation to conventional or stand-alone i.e. non-MOS markets. This is presented in tabular form andthen developed and explored via data flow diagrams (DFD)1 whichare a technique of structured systems analysis and designmethodology. An explanation of DFDs is provided in theaccompanying notes2, for the benefit of readers not familiar with thissystems engineering method of representing dynamic processes.

The issue of how counter-parties behave in such non-MOS marketsneeds to be explored using DFDs because, without a firm groundingin this process, which creates the open interest and volume, it isimpossible to appreciate the significance of the distorting effects thatMOS markets are capable of introducing if they are viewed from aconventional viewpoint. A recapitulation of the key points of theprevious paper is provided, followed by an in-depth representation ofhow MOS-able markets operate in terms of the linkages that appearthrough participants invoking the facility at either end, at differentexchanges, on different continents. DFDs are again used so allowinga comparison with non-MOS markets to be made and as a resultsituations can be identified where the conventional approach toOIV&P analysis is likely to give rise to spurious results, if applied toactive MOS markets.

THE STATUS QUO

The conventional wisdom regarding the qualitative relationshipbetween open interest, volume and price changes for exchangetraded futures contracts can be found in a few sources; Hadady(1987), Teweles (1987), Miner (1990), Kallard (1991) and Shaleen(1991). Over the years it is apparent that the original interpretationprovided by Hadady (1987) has been used as the basis forsubsequent presentation. Of these, Miner (1990) provides the mostcomprehensive treatment that has been discovered, and a summaryis provided in Table 1. Of key importance to the speculator [and to alesser extent, the hedger] is the expected shifts in price level forgiven combinations of changes in open interest and volume.

An unstated assumption underpinning this and other, similar,treatments of the issue, is that the interpretations regarding open

interest, volume and price change behaviour are appropriate to asingle or stand-alone market. In earlier decades this would have beena reasonable assumption, but the world of the markets has sinceglobalized and moved on. Only Shaleen (1991) refers to theexistence of MOS markets, but this is in passing, and no effort ismade to explore their impact on the validity of conventional wisdom.

OPEN INTEREST CHANGES AND PARTICIPANTMIX

The reason why the changes in open interest depicted in Table 1occur is due to the interaction of participants of differing motivationswithin a market of interest. The key features of the conventionalview take the form of eight cases representing changes in openinterest from which the behaviour of a markets participant mix can


Open Interest, Volume and Price Analysis: The Special Case ofMarkets with Inter-Exchange Mutual Offsetting Systems (MOS)

By Dr Michael Wignall MSTA

CASE OPEN INTEREST TRANSACTIONAL PRICE IMPLICATIONS FOR PRICE# BEHAVIOUR VOLUME BEHAVIOUR BEHAVIOUR IN IMMEDIATE

BEHAVIOUR FUTURE

HI - + HI - + LO - +

1 Perceived rally trend likely tocontinue

2 ditto

3 Reversal of perceived trendlikely

4 End of perceived long termdecline and creation of marketbottom likely

5 ditto

6 Perceived existing downtrendlikely to continue

Table 1: Conventional Wisdom Regarding Open Interest, VolumeAnd Price Changes

Derived from: Miner (1990) Vol. 1. Text, p. V/OI-17

Abbreviations: - = decreasing + = increasing

C OPEN INTEREST INFERRED PARTICIPANT INTERACTIONA IN TERMS OF PARTY & COUNTER-PARTYS ACTIVITYE

#

COLLOQUIAL LOGICAL VIEWDESCRIPTION

Reduced Purchases by old sellers existing Shorts buy to1 from old buyers become Flat whilst existing

Longs sell to become Flat *

Unchanged Purchases by old sellers existing Shorts buy to2 from new sellers become Flat whilst Flats

sell to become Short *

Unchanged Purchases by new buyers Flats buy to become Long3 from old buyers whilst existing Longs sell to

become Flat *

Increased Purchases by new buyers Flats buy to become Long4 from new sellers whilst other existing Flats

sell to become Short *

Unchanged Sales by old buyers to existing Longs sell to5 new buyers become Flat whilst Flats

buy to become Long *

Reduced Sales by old buyers to existing Longs sell to6 old sellers become Flat whilst existing

Shorts buy to become Flat*

Unchanged Sales by new sellers to Flats sell to become Short7 old sellers whilst existing Shorts buy to

become Flat *

Increased Sales by new sellers to Flats sell to become Short8 new buyers whilst other Flats buy to

become Long *

Table 2 Conventional Wisdom Regarding Participant Interaction AndResulting Changes In Open Interest For A Non-MOS MarketDerived from: Teweles (1987), p. 177.

Note: * the assumption is that in so doing, each participant offsets the other.


be inferred, or the opposite i.e. given information regarding thenature of the participant mix it is possible to deduce the behaviour ofthe open interest. Details are provided in Table 2 which contains thecolloquial descriptions of behaviour of potential participants withdiffering sentiment becoming counter-parties to each other, phrasedin the form found in market literature. An additional column hasbeen added containing the logical equivalents, to enable a structuredanalysis of the dynamics of one of the cases to be conducted, usingDFDs.

A central aspect of this logic is that the number of long positionholders always has to equal the short position holders, at anyinstant in time, irrespective of what motivations drive the behaviourof the participants mix. This is an inviolable characteristic which isdue to the bi-lateral nature of the entity that is being traded - whichis a contract.3 This aspect of derivatives markets is rarely emphasisedin the literature on speculation and there is a consequential tendencyfor analysts and traders with a speculators mindset, simply to viewmarkets as price series changing through time. However, this ignoresthe realities of how the price levels were created, when they did.

PARTICIPANT INTERACTION AND COUNTER-PARTY FORMATION

The bi-lateral nature of futures contracts results in a symmetry ofinteraction between market participants, whether they realise it ornot. This can be illustrated with an example taken from one of thesituations described in Table 2. An arbitrary choice is Case 4, andthis is adopted in exploring non-MOS versus MOS-able marketbehaviour. For ease of explanation, the simplifying assumption is thatthe participants orders are actioned by their respective brokers at thesame instant in time and that these brokers fill their orders againsteach other. The process involved is illustrated by the DFD at Figure 1.

The starting situation is that Participant A is a potential buyer andparticipant B is a potential seller. Both are initially represented in theDFD as being outside the market in terms of their involvement i.e.state 1.

If the potential buyer A [who desires to be Long i.e. take thedelivery side of the contract] meets a potential seller [who desires tobe short i.e. make the delivery side of the contract] then the auctionclears at either the market price prevailing at the time or at the pricerepresented by the bid [to buy] being hit by the other broker or theoffer [to sell] being lifted by the other broker. Thus a transactiontakes place at an existing price or a new price is formed, dependingon which of those activities occurs. The Buy order, from participantA, which is in an [u]n-executed form is represented by the dataflow Ob(u). Likewise the Sell order, from participant B, which is alsoin an [u]n-executed form is represented by its own data flow Os(u).The point in time where they meet and are executed by the twobrokers is represented by the order execution transformationsymbol. At this point each of the two unexecuted orders, Ob(u) andOs(u) are transformed into two sets of orders that have been[e]xecuted. The resulting flows thus become Ob(e) and Os(e),respectively.

A new bi-lateral contract thus comes into existence, by virtue of theParticipant A [the potential buyer] offsetting Participant B [thepotential seller] and the potential seller [Participant B] offsetting thepotential buyer [Participant A]. The offsetting process is synonymouswith the each participants orders being executed by the brokers through being filled. This results in each participant having itssentiment transformed into commitment i.e. the Flat situation of bothparticipants becomes something else.

In the case of participant A, that something is Long commitment,and for B, Short commitment. With the ownership of commitment,each participant has had its condition changed to State 2 with regardto the market. They may well be existing off-floor in a physical sense,but they have now become an integral part of the market itself andconsequently their behaviour will be driven by it, to a greater orlesser degree, depending on their motivation for participation in it.This is because shifts in the markets price clearing level will influencetheir subsequent behaviour. For example, speculators in particularreact to margin calls by nullifying their commitment through exitingthe market - or increasing the size of their commitment throughtrying to exploit a perceived price trend. Thus by taking oncommitment and achieving State 2 they come to be represented asexisting inside the market system in terms of DFD logic.

Participant A will see itself as the initiating party, as viewed fromwithin its personal frame of reference, with participant B its counter-party. Similarly, participant B will see itself as the initiating party, asviewed from within its personal frame of reference, but withparticipant A as its counter-party. However, both parties remainanonymous to each other by virtue of the broker intermediaries andfew speculators trouble themselves with thinking about who waslikely to be on the other side of their trade, when their order is filled.

There is, however, a further dimension to the internal dynamics ofthe offsetting process, that needs to be understood. As A and B arethe only active market participants involved, they offset each otheri.e. B acts as the counter-party to A, whilst A acts as the counter-party to B. This symmetry is represented after the respective Buy andSell orders come to be executed by the qualifiers accompanying State2. For example Participant As state is qualified by having itannotated with DCP= B (Short) indicating that the direct counter-party is Participant B which is Short. Likewise, Participant Bs state isqualified by having it annotated with DCP= A (Long) thusindicating that the direct counter-party is Participant A which is Long.

These qualifiers allow key information to be presented, post orderexecution. They indicate that, on assuming their desiredcommitment, each participant has been locked into each other. Insimple terms, this locking in represents the liability of Participant A(Long) and Participant B (Short) to fulfil the legal obligations of thecontract specifications i.e. eventually take delivery or make delivery,respectively against each other.

Figure 1 is logically correct, in that it represents the process involvedin the formation of a bi-lateral contract, and it also represents what isimplied in Table 2, i.e. the creation of a Long position for newbuyers at the same time as a Short position is created for newsellers. Unfortunately, it does not capture a subtle additional factorwhich is invisible to the participants; one that is introduced to allow akey shortcoming in the process depicted in Figure 1 to be overcome.

This is that the only way that either of the two participants can offsettheir positions and exit the market [so as to avoid their contractualobligations] is for both of them to agree to cancel their existingcommitment, through offsetting against each other. If one partyrefuses, the counter-party remains locked into the commitment via itscounter-party, and will be forced, by law, to fulfil its contractualobligations.

There is no half-way house. Even if Participant A wished totransfer its Long commitment and found a third party, Participant Cwhich was willing to take on its Long commitment, the process asdepicted in Figure 1 is incapable of coping, because Participant B isthe direct counter-party to A and could insist on the status quo. Thusthe model represented by Figure 1 is logically valid for only twospecific situations (a) two parties agree to form a contract and (b) thesame two parties both agree to annul the contract. As such, thearrangement is extremely restrictive. It is not conducive to the

Figure 1: A Representation Of The Order Execution (OE) ProcessNote: DCP = Direct Counter-Party


cancellation of commitment at a moments notice by either of theparties. Neither is it possible for a participants existing commitmentbe annulled by having it taken on by a third party.

Exchanges need to offer their users near instant execution of ordersto cater for speculation or hedging activities, both of which are time-sensitive, in their different ways. The key to solving the problem oflocked counter-parties is for an entity to be made available thatwill act as a counter-party to any active participant, irrespective ofthe requirements of sentiment, size of order, or timing.

THE UNIVERSAL COUNTER-PARTY

The solution is provided by an exchanges Clearing House system.One of its purposes is to provide a means of allowing freemovement of established commitment i.e. divestment of it by a partyto a third party, ad infinitum, without the permission of the originalcounter-party which allowed it to be brought into existence in thefirst place. This is achieved through the legal arrangement ofnovation.4 This allows the normal obligation between the two partiesto a contract to be severed, without the destruction of thecommitment that has been entered into, and have it taken on byother parties. Novation is unusual in the day to day world outside themarkets and is only possible on a large scale in the markets becausethe contract specifications are deliberately standardized to allow it tobe applied.

The process of novation allows the Clearing House to assume theposition of counter-party to both Participant A and B. One methodof representing the process is in Figure 2, which is a logical expositionand does not necessarily represent a true picture of the real-worldprocess as implemented in any particular exchange.

It has been presented in this way so as to provide a natural extensionof the process depicted in Figure 1. The left hand side of Figure 2represents the right hand side of Figure 1, but with the addition oftwo Clearing House participants, one for each, both starting inState 1. The Figure shows Participant B who is Short throughinteracting with A, undertaking a transaction with the ClearingHouse, which is Flat. This is a notional transaction which involvesone Clearing House participant buying Participant Bs counter-party commitment i.e. the DCP = A (Long), whilst Participant Bsells it to the Clearing House. The result is that Participant B endsup with the Clearing House which is now Long, as its notionalcounter-party. This is indicated by Participant B gaining the qualifierNCP= CH (Long).

The opposite occurs with Participant A who is Long throughinteracting with B, undertaking a transaction with the ClearingHouse, which is Flat. Again, this is a notional transaction whichinvolves one Clearing House participant buying Participant Ascounter-party commitment i.e. the DCP = B (Short), whilstParticipant A sells it to the Clearing House. The result is thatParticipant A ends up with the Clearing House which is now Short, asits notional counter-party. This is indicated by Participant A gainingthe qualifier NCP= CH (Short).

This may seem a convoluted academic exercise until it is realised thatboth A and B are now free agents in terms of what they do withtheir commitment. They have been released from each other as aresult of being re-assigned notional counter-parties, and can now actindependently, in order to annul their commitment by transferringit to a third party, should they wish. They both, however, remain anintegral part of the market and are thus subject to its influence, interms of their behaviour to the positive and negative equity changesin their accounts.

The process that actually takes place in the market is bestrepresented by combining Figures 1 and 2 and viewing the orderexecution and the novation as taking place simultaneously, as acomposite operation. The result is shown at Figure 3, and is the formadopted for the remainder of the paper. It shows all participants,both actual in terms of A with B and notional in terms of the ClearingHouse system starting life Flat, the combined order execution andnovation process subsequently transforming them into participantswith either Long or Short commitment, each with their appropriatecounter-parties.

In addition each of the participants have been annotated as beingpart of the CME, in order to show that the transformation process isoccurring in the same i.e. stand-alone market. It can be assumed thatthe activity occurs in the CMEs pit.

CONSEQUENTIAL IMPACT ON VOLUME ANDOPEN INTEREST

If the Participants A and B were the only active participants duringthe time the market was open for trading, the open interest would

Figure 2: A Representation Of The Novation Process Note: DCP = Direct Counter-Party , NCP = Notional Counter-Party, CH = Clearing House

Figure 3 A Representation Of The Combined Order Execution AndNovation (OE&N) Processes

Notes: DCP = Direct Counter-Party, NCP = Notional Counter-Party, CH = Clearing House

Table 3: The Impact Of Two Flat Participants Creating Commitment.

CME (Pit)

STAGE PARTICIPANT PRE EXECUTION POST- IMPACT IMPACT ON# OFFSETTING COMMITMENT EXECUTION ON TRANS-

ACTIVITY COMMITMENT OPEN ACTIONINTEREST VOLUME

1 A(B) buys 1 A = Flat A = Long 1 ) )) = +1 ) = +1

2 B(A) sells 1 B = Flat B = Short 1 ) )

CUMULATIVE CHANGE = +1 = +1


have increased by 1, as would the transactional volume. Thetransactions involving the Clearing House becoming counter-partiesto A and B do not affect the open interest or volume figures, as thetransactions are notional. This rationale is illustrated in Table 3.

THE TRANSFER OF COMMITMENT TO ATHIRD PARTY WITHIN THE SAME MARKET

With the explanation of the combined order execution and novationprocess represented by Figure 3 completed, it is now possible to usethis to illustrate how one participant can annul its commitment byseemingly transferring it to a third party within the same market,when it is a single or stand-alone i.e. non-MOS market, and in sodoing become Flat again. This needs to be understood before theactual MOS situation can be tackled. The non-MOS process isrepresented by Figure 4 and it involves Participant A which iscurrently Long becoming Flat, whilst a new Participant C which isFlat enters the market and becomes Long.

The DFD shows Participant A already Long with its notional counter-party as the Clearing House which is Short, and the Clearing Housealready Short with its direct counter-party as Participant A which isLong. This situation represents the outcome of the process depictedin Figure 3. The new participant C starts Flat, as does its notionalcounter-party, the Clearing House. The arrival of the order to Sellfrom Participant A coinciding with the Buy order from Participant Callows the necessary offsetting to occur and, with it, the novationprocess. The Clearing House which was Short in order to act ascounter-party to A, buys to become Flat and the Clearing Housewhich was Flat goes Short in order to act as counter-party to C,which has now become Long. The end result is that Participant A hasleft the market, as has its notional counter-party. Participant C is nowpart of it, together with its new notional counter-party. Participant Cis also free to act independently of any of the other participants whomake up the market, as was A.

CONSEQUENTIAL IMPACT ON VOLUME ANDOPEN INTEREST

If Participants A, B and C were the only active participants during thetime the market was open for trading, the open interest, which waspreviously 1, would remain unchanged. However, due to Participant Csoffsetting against Participant A the transactional volume increases by 1.Once again, the transactions involving the Clearing House uncouplingitself from B and becoming the counter-party to C do not affect theopen interest or volume figures, as the transactions are notional. Therationale is illustrated in Table 4, which is an extension of Table 3.

The impression given in the existing literature is that Participant Ahas transferred its Long commitment to C. In reality all that hashappened is that through coincidence As order to sell resulted in itgoing Flat, whilst Cs order to Buy resulted in it going Long. In

another situation exactly the same orders could have resulted in atotally different outcome i.e. if A was Flat it would become Short,whilst if C was Short it would become Flat. The impression thatcommitment is transferred is an illusion stemming from the simplifiedway that the interaction of the participant mix is presented in thestandard market texts on the subject.5

It is important to appreciate that the illusion exists. It assumes somesignificance when MOS-able markets are examined, which involvethe transference of commitment between different exchanges.

Notes (Part 1)

1. It is believed to be the first time that DFDs have been used toexplore the issue of open interest, volume and price changes. Theterminology and logic incorporated in these DFDs are the authorsand have been developed as a by-product of an ongoing researchprogramme into exchange traded commodity derivatives markets.

2. DFDs provide a means of representing systems in a structuredform and in so doing encapsulate the understanding of the nature ofthe system, derived from analysing its constituent parts and theprocess(es) that define its character. This can be achieved via fourentities (1) data flows or the passage of information through thesystem, (2) data stores that represent accumulations of informationthat are not moving, (3) processes representing the action that isimposed on incoming information to transform it in some way into itsoutgoing form, and (4) external entities representing sources ordestinations of information that exist outside the system boundarywhich has been chosen by the analyst to define that part of the totalactivity that needs to be scrutinised. The symbols are:

Data flows that are inputs to a (3) undergo some form oftransformation within it and then exit the symbol in a modified state,as outputs. DFDs have no starting or stopping points, no timeelement or indications of decision making. In that sense they areanalogous to road maps which are also very useful.

3. This is in contrast to an asset, in the form of a stock certificate,which is involved in a stockmarket transaction, and which can beviewed as a mono-lateral entity. Failure to appreciate the subtledifference results in analysts, in particular, viewing futures markets nodifferently than stockmarkets.

4. For amplification see Treitel, G. H., The Law Of Contract, 8th ed.,Sweet & Maxwell/Stevens & Sons, London, 1991, pp. 577, 604 or Merriam-Websters Dictionary Of Law, http://dictionary.findlaw.com

5. Legal texts emphasise the true nature of novation i.e. a liability isextinguished and a new one immediately put in its place, rather thana transfer of liability taking place.

Copyright Michael Wignall 2000

Figure 4: A Representation Of The Apparent Transference OfLong Commitment To A Third Party In A Stand-alone Non-MOSMarket Situation

Table 4: The Impact Of One Long Participant Exiting The Market AsOne Flat Participant Enters

CME (Pit)

STAGE PARTICIPANT PRE EXECUTION POST- IMPACT IMPACT ON# OFFSETTING COMMITMENT EXECUTION ON TRANS-

ACTIVITY COMMITMENT OPEN ACTIONINTEREST VOLUME

1 A(B) buys 1 A = Flat A = Long 1 ) )) ) = +1

2 B(A) sells 1 B = Flat B = Short 1 ) )) = +1

3 A(C) sells 1 A = Long 1 A = Flat ) )) ) = +1

4 C(A) buys 1 C = Flat C = Long 1 ) )

CUMULATIVE CHANGE = +1 = +2

ERRATUMIn the authors postscript to his previous article (Issue No. 38, July2000, page 11), the official acronym for the Singapore Exchangeshould have read SGX, not SAX.


Following a brief rally in early June the SET index resumed itsdownward trend to the end of July, where it hit an intra-day low ofjust under 283. A favourable report from Salomon Smith Barney thatMorgan Stanley may change the basis of its widely traded MSCIglobal benchmark indices, which would have a major beneficialimpact on the SET index, prompted a strong rally on the 1st August,as local investors rushed back into the market on hopes that anymethodology change would see the SET weighting increase from thecurrent 2.1% to as much as 3.6%. Follow through buying, with a bigincrease in trading volumes and even foreign investors showing someinterest, pushed the SET index back above the psychologicallyimportant 300 level. However, the index needed to overcome a lot ofnear term overhead resistance and it was always in doubt as towhether or not this rally would signal a trend reversal, or simply fizzleout as yet another Dead Cat Bounce. Of course, the Bulls believed itwould be different this time but forgot that past experience provesthat these are the three most expensive words in the Englishlanguage. If the index had broken through resistance at 330, a shortterm buy signal would have been triggered on the Gann WeeklySwing Chart. However, as the major trend in the market remaineddown, traders needed to be very nimble to take advantage of thisbear market rally, and would have been well advised to quickly lockin any short term gains as soon as it became clear that this resistancewould not be broken, and the index fell below the 50-dayexponential moving average. Over the past two years the USstockmarket has peaked in July/August and fallen steadily intoOctober. This year, the downtrend got underway at the beginning ofSeptember, dragging down Thailand with the rest of the globalmarkets. The chart below shows the Dow Jones Industrial Averagewhere a Diamond topping pattern can be clearly seen. Following adownside break out of the triangle the index pulled back from theabyss as it catapulted from support at the one-third speedline in aspectacular bear market rally, taking the Dow back up to 11,000.This rally has impacted positively on global markets, includingThailand, which have all rallied over the past few weeks.

So the question is, Where do we go from here? In Thailand, themajor trend remains down, but the current rally from the Octoberlow is extremely encouraging, as the Gann Weekly Swing Chart hasturned up. The fact that the October intra-day low represented anexact 50% fall in the index from the 499.5 level at the beginning ofthe year is also of significance from a technicians point of view. Ameaningful rally can always be anticipated when the index reachesimportant Fibonacci reversal levels in both price and time. Measuringfrom the July 2000 low to the August 2000 high, a Fibonacci 61.8%downside target of around 254 can be calculated. This was within

2% of the actual October price low. From the SET weekly chart it canbe seen that the index has now made a very bullish upside breakfrom the falling wedge, and the October low was pinpointed exactlyby a Fibonacci Golden Section. A break above the 13-Weekexponential moving average could see the index work its waysubstantially higher over the next few months.

Focus on Thailand By John Arter MSTA

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Market Technician No39