November 1999
Contents
1. NOVEMBER 1999 AIQ Opening Bell EXPERT DESIGN STUDIO AT WORK continued An example of a Harami candle stick pattern appears in Figure 1 On October 4 IBM s real body rectangu lar box on the candlestick chart is engulfed by the previous day s real body Another Harami is found on September 20 The Harami pattern is thought to be a reversal pattern A stock in an uptrend that forms a Harami pattern is susceptible toa downward move Conversely a stock ina downtrend that forms a Harami often moves higher Our testing using the Expert Design Studio package however shows that the trend is fairly insignifi cant and that stocks with Harami candlesticks typically underperform the market whether they are in an uptrend or a downtrend TradingExpert Pro s Expert Design Studio module provides pre built rules that can be used to search for many different candlestick pat terns Since candlestick formations are open to interpretation some candlestick enthusiasts may disagree with how we created the rules For example when a textbook says a candlestick has a large real body followed by a small real body what exactly is large and what is small r Tenhi ahi EDS E dgn i ene ii Let Yew Hain ojs oeme j So lr B m m B al r Penhi d hi EDS ed a li Da ect iea Hip ojs oeme ej EE arra Abg Jimi ari daha jaa End tect dete DT East LL Loom EEEEEEEEEE EEEEEEEE2. NOVEMBER 1999 7 ATQ Opening Bell MARKET REVIEW market timing strategy of exiting the market in the summer and re entering during an October selloff has once again proven to be a good strategy Those that see the month of October as a glass half full recognize that good buying opportunities often occur during the month Unlike last year this October s low point will not likely lead to a strong rally That s because the selloff was much more mild than it was last year Investors in large cap Nasdaq or technology stocks wouldn t even have known there was acorrection The Nasdaq Composite barely moved lower and closed at a new high at the end of the month l t seems too easy but a simple We often focus on daily chart analysis but we can turn to weekly charts for a longer term perspective In October the weekly Stochastic indicator moved into oversold territory Figure 11 During the bull run in the 90s these signals have proven to be effective see arrows Fromits July high to its October low the S amp P 500 corrected 12 October was an active month for the AIO market timing model and we had some whip LELT l De y j jom hja ga fate oo daa fe Aaf e Ba aa aaae eading into _ O O OO October the AIQ Pea timing model was on a September 27 buy signal An additional 100 buy signal was registered on October 4 The model switched to a sell mode on October 12 when it registered a 100 sell
3. OR Opening Feature Expert Design Studio Short Selling Model 000 Sections S amp P 500 Changes Tools of the Trade RSI ee sas User Created Indicators 6 Market R VICW cccccsssssseess Data Maintenance The Opening Bell Monthly is a publication of AIQ Systems David Vomund Chief Analyst P O Box 7530 Incline Village Nevada 89452 VoL 8 Issue 11 EXPERT DESIGN STUDIO AT WORK SHORT SELLING CANDLESTICK MODEL An Effective Screening Technique for Shorting Stocks By David Vomund or most of the 1990 s it was very H difficult making money by short ing stocks That s because the market increased with very few correc tions Over the last two years however the market has increased in value but there have been corrections that were large enough for short sellers to do well Bell Monthly NoveMBER 1999 and buy low Short sales are accomplished by borrowing stock for use in the initial trade then repaying the loan in a later trade DAVID VOMUND Let s clarify this with an example At the start of the day Mr Williams owns 100 shares of IBM which are being held in street name at AG Edwards Later in the Even if you a elon Hanna places nae short The worst rules for buying vie cates pene en stocks long can be the best rules herbroker AG short sale can for selling stocks short the Edwards to help diversif t t
4. aa ae ceo E A Ra JIR 3E nem store Husnes Mache Dat A Hexen in vit Fra Hod pra F i IE ER Up i868 Goan 58 109 7H 147 272 116 Stk 137 F406 112 FAB 140 Fiske 118 12 i G Hi l Demad Tag ET 172 24250 6 42 HA Slochaalic Cet Tremi waddle MOTES from best to worst based on their effectiveness All the rules were tested for long trades The worst rules for buying stocks long can be the best rules for selling stocks short Our testing found the least effective rules for buying stocks long involve two candlestick chart pat terns the Hanging Man and the Gio ect ipea bein ojs Dar malar e lo Spey Sumwagy Parian Fimer Pierre Shard kari daha 1a Ered tot dete Ure LLL Loowrs Pet ee en Hirbs of heh in Har Pere X5 ji Aun partir pa heia Fil BS ig Hamren Preiars BE Bi js Anaika Dadar ij pi Pops jin dy Aung Pret Lar 11s LEE Ti ea Ayn SP Prod Lare Sa Bide ais Probabelty ajia ibi Aang rra ADI HE Ei BF E e ra 174 Amana SF Bae tH cdl iSi Fanaa Pick Aiae 1 18 Fra Hos pars Fi Harami We will use the Harami candlestick pattern in our model With a candlestick chart the real body is the difference between the opening price and closing price For the Harami pattern a small real body follows a long real body This pattern is somewhat comparable to an inside day pattern in bar charts Figure 2 EEE HLH
5. below zero and therefore do not involve a loss greater than the total investment But a stock sold short could theoretically produce an unlimited loss since there is no ceiling on a stock s appreciation potential Those who shorted Qualcomm or Nextel can appreciate this fact Since a short sale involves a loan there is a risk to the brokerage firm that the loan will not be repaid To protect the broker the short seller does not have access to the money received from the initial sale of securities and a margin requirement must be met In developing our short selling model we are using the research that appeared in the June 1999 Opening Bell In that issue we tested all the pre built Expert Design Studio screen ing rules that come with TradingExpert Pro and ranked them PLEASE SEND CORRESPONDENCE TO Opening Bell Monthly G R Barbor Editor P O Box 7530 Incline Village NV 89452 AIQ Opening Bell Monthly does not intend to make trading recommendations nor do we publish keep or claim any track records It is designed as a serious tool to aid investors in their trading decisions through the use of AIQ software and an increased familiarity with technical indicators and trading strategies AIQ reserves the right to use or edit submissions For subscription information phone 1 800 332 2999 or 1 775 831 2999 1992 1999 AIQ Systems Pal sE Charts Ghat hima Diam Epke Tago aod Help Eja af ela Bt
6. 1 12 99 Amgen AMGN 2 1 11 22 99 Phone com PHCM 2 1 11 15 99 ChoicePoint CPS 2 1 11 25 99 Trinitech Sys TSI a2 11 16 99 Advance Paradign ADVP 2 1 12 01 99 Name Ticker Changes British Stell PLC BST to CorusGroup PLC CGA Foodmaker Inc FM to Jackin the Box JBX Hadco Corp HDCO to Hadco Corp HDC WestPoint Stevens Inc WXS Ameritech Corp AIT Bank Boston Corp BKB Capital RE Corp KRE Centocor Inc CNTO Data General DGN Everen Capital Corp EVR Frontier Corp FRO Lone Star Industries LCE Marshall Industries MI Pioneer Hi Bred PHB Sbarro Inc SBA Smithfield Foods Inc SFDS St Paul Bancorp SPBC Unitrode Corp UTR NOVEMBER 1999
7. EE EEHEEHE Phorebear of heria n al 11 TH oT Asm partir peer heja Fil ri Hamren Preiars a5 ee EAE Aniwa liradan Hi ijs B Oey jie idx Ange Pret Lar fides 155 jis Sx Avg SP Preiars Six Etis US i Probab LEF ra Eps Ame anne Al Mits Brie fra ES Anaa iF Bae tH cdl TeSi Frand Pick Fister imi Fra Halip pars Fi lal Figure 3 For our model we used AIQ s pre built Harami rule without change To open the pre built Harami rule go to the Expert Design Studio module and select File then Open Double click the EDS Strategies folder then double click the Basic Indicator Strategies folder next double click the Candle stick folder and finally open the Figure 4 ar Fimer aats Jimi Hari daha Lines eT Endtect dete Leia E ies Loom EEEEEEEEEE EEEEEEEEEE en Pore cof hejan Har iri EE ri Amn partir peer bade Hamren Probar ies jae By Aik lirain Arps pigs jie Sty Age Pret Las LE pa LESE t LE i Amga SP Preiars jl 17 iiiz mi7 Probabelty Ca as injis Aang raa All iiir Egiz Hi ii Arnas iF E Hi 1E51 Fars Fir Piste 112 Fra Haig pars Fi Harami file In Figure 2 we test the Harami pre built screening rule on a database consisting of the S amp P 500 stocks using a sell strategy of 85 principal protect and a 95 profit protect above 15 We tested the model on the long side We see that after a Harami candlestick pattern stocks greatly underperform the market The average stock incr
8. d overbought and due for a correction A sell is regis tered when the indicator falls from above 70 to below 70 When the RSI value falls below 30 the security is oversold and will likely rally A buy is registered when the indicator rises from below 30 to above 30 Examining Figure 6 we see the two indicators tend to move together but they reach overbought and oversold levels at different times Both RSI indictors work beautifully on non trending securities When a security is in the upper end of its trading range RSI is often above 70 and ready to give a sell When a security is near the lower end of its trading range RSI is often below 30 and ready to givea buy Using the buy and sell signals in their simplest form the RSI indicators are not effective for trending securities For an uptrending security the RSI will give sell signals as the stock moves higher When the overall market is in an uptrend few stocks will give RSI buy signals and those that do are market laggards W NOVEMBER 1999 AIQ Opening Bell USER CREATED INDICATORS Want To App New INDICATORS To YOUR TRADING EXPERT PROGRAM HEeErRE s How By David Vomund t AIQ s fall seminar techni A cal analyst John Murphy gave an outstanding presen tation on indicator analysis and sector rotation One of the indicators that he used was calculated as the difference between a10 week moving average and a 40 week moving average This is n
9. eased 1 14 in the 70 days after a Harami pattern An equivalent trade in the S amp P 500 gained 3 46 Hence a bad rule for buying stocks long can be a good rule for selling stocks short The second and final rule in our short selling model uses the RSI AIQ indicator Contrary to what you d believe a buy signal on the RSI AIQ indicator is bearish The pre built rule that says the RSI AIQ must rise from below 30 to above 30 was one of the worst rules for buying a stock long Saying that an RSI AIQ buy signal is bearish may sound controversial Yet short sellers often short downtrending stocks after a short term rally These are equivalent patterns The RSI AIQ indicator is Expert Design Studio continued on page 4 NOVEMBER 1999 3 AIQ Opening Bell EXPERT DESIGN STUDIO AT WORK continued fairly insensitive so it takes a lot of downside movement for itto move to oversold territory a value below 30 When a weak stock advances it can give an RSI AIQ buy signal Figure 3 displays a backtest of the AIQ RSI buy signals using the same criteria that was used for Figure 2 Again the test was for buying stocks long We see that buying weak stocks after a short advance is a losing strategy Inthe 70 days after an AIQ RSI buy signal the average S amp P 500 stock only advanced 0 10 whereas the S amp P 500 gained 3 41 Our final short selling screening model combines the Harami and RSI AIQ rules That is t
10. en the MA Dif eds file In the Plot Type dialog box select Histogram and click Next The Histogram Indicator dialog box will appear In the box labeled Description type aname for the new NOVEMBER 1999 AIQ Opening Bell USER CREATED INDICATORS continued indicator From the UDF to Plot text mre box select MADif Figure 8 Click Chat Wea Dram Expos Tagit Window Hap Finish Eiee fe elif sjan u aE e When the Custom Indicators dialog Ean eann box reappears click Done The newly created indicator will now appear as one of the choices in the control panel of the AIQ charts Figure 9 plots the Semiconductor Index SOX along with its 10 week and 40 week moving averages Our newly created indicator MA Dif which looks at the difference between two moving averages is plotted z er a a Whenever the moving averages cross each other see arrows our MA Dif indicator crosses the zero line John Murphy points out that the MA Dif indicator gives you the advantage of looking for divergences For example the SOX hit a new low in the summer of 1996 but the MA Dif indicator was moving higher The same thing happened last fall A negative divergence appeared this Fra Hobe para F ADX indicator without the ADXR line we can create a Money Flow indicator This is easily accomplished using the and plot a moving average of the summer when the SOX rallied tonew following EDS code indica
11. he model looks for stocks that have a Harami pattern and have given an AIQ RSI buy signal anytime in the last two days A backtest of the final model is found in Figure 4 Since this model was designed for screening short selling candidates we tested the model on the short side As before we used 85 principal protect and 95 profit protect above 15 We see the average short trade made 0 87 per trade If you shorted the S amp P 500 index you would have lost an average of 3 17 per trade This model actually shows a profit by shorting stocks over the last two years An example of a stock that fits our model is Novell Inc on October 5 Figure 5 shows that it formed a Harami pattern as its real body was contained within the previous day s real body At the same time that the Harami was formed the RSI AIO indicator gave a buy signal This Pal aE Charts Ghat hea Grew Epika Taga hinia Hap f j maa aeaa fee ajaja fin w Se TETTA 15 mE Howell inc Die Fra Halip prs Fi Wie Open iF and ee ER Up E Goan 58 CELF 24 19 18 17 ee 13 FAi6 2 15 06 Th Iriki Fa yaz Tm Scorn fF Slochaalic 7556 a0 54m JE W J w 16 00 O00 F Hoj indicator moved from below to above the lower horizontal line This short selling technique has worked well in the type of market that we ve seen over the last few years We ll continue to monitor its perfor mance Our confidence in the mode
12. i b sell 100 shares pees peal 2 east effec ive rules for buying of IBM short O Aponte stocks long involve two candle Mr Williams liothatislong Stick chart patterns the Hang Pelieves IBM the market In M d th H dd will move A ing Man an e Harami higher while this article we ll develop Ms Hanna believes IBM an effective screening technique for shorting stocks When you buy a stock long you are betting that the security will increase in value Hence the old adage buy low and sell high For short sales the saying might be reworded as sell high will fall In this case AG Edwards takes the 100 shares of IBM that they are holding in street name for Mr Williams and sell them for Ms Hanna to some other investor Mr Jones If Ms Hanna is right and the price of IBM falls she can buy her position back at a profit Expert Design Studio continued on page 2 AIQ Opening Bell EXPERT DESIGN STUDIO AT WORK continued Mr Jones would have a paper loss since he is long the stock What if IBM pays a cash dividend during the short sales IBM sends the dividend to Mr Jones the holder of the securities However since Mr Williams still owns the IBM stock he also expects a dividend check In this case the short seller Ms Hanna pays the dividend amount to AG Edwards who in turn sends a dividend check to Mr Williams There are risks to short selling Stocks that are bought long cannot drop
13. ing its values and normalizing all values to a range of between 0 and 100 The actual formula is calculated as follows RSI 100 100 1 RS where RS Average of x day s closing prices on up days divided by the average of x day s closing prices on down days With this formula in mind the difference between the RSI Wilder cas a Cherig cialaj Pid al ke AE Bl FE Jones Dati ot os Sy Wve v a a m z P aL wr ama Lerla ati Fra Hod para Fi Sin ewe 11520 il iihi 1100801 LOTR OI at i jir een MUN yi 12 al a 4 J726 M qa i yi thy y ny ap JE m 6400 j w 0 00 96 00 a m M Jz E ono O iz Desmedd indicator and the RSI AIQ indicator is how the averages for the up and down days are calculated In AIQ s calcula tion exponential moving averages are used whereas Wilder s version uses simple moving averages It sounds like a small difference but an exami nation of the resulting indicators can yield significant variations Wilder s RSI is much more volatile than AIQ s RSI To partially offset this the default value for the moving average time period was lowered from 14 which is the number of days Wilder originally used to 7 for the AIQ version of RSI Figure 6 shows the Dow with both versions of the RSI The most simple interpretation of the RSI is when its value moves above the 70 level the security is considere
14. l will increase the longer it works AIQ users can download the model s file from AIQ s web page at www aig com Click on educational products and then select Opening Bell newsletter Inthe lower right corner select the file that corresponds to the November Opening Bell E David Vomund publishes VIS Alert a weekly investment newsletter Fora sample copy go to www visalert com or call 775 831 1544 About Expert Design Studio AIQ s Expert Design Studio EDS was developed for users who want to create and test their own customized screening reports or mechanical trading systems For those unfamiliar with Expert Design Studio an introductory tutorial is included in AIQ s New User Guide Full documentation can be found in the TradingExpert Pro User Manual Part 2 page 393 S amp P 500 Changes Analog Devices ADI replaces Ameritech AIT ADI is added to the Electronics Semiconductors ELECTRONS group T Rowe Price Associates TROW replaces Data General DGN TROW is added to the Investment Management INVESTMG group Leggett amp Platt LEG replaces Cyprus Amax Minerals CYM LEG is added to the Household Furnishings amp Appliances HOUSEFUR group El Paso Energy EPG replaces Sonat Inc SNT EPG is added to the Natural Gas NATURALG group Comverse Technology CMVT replaces ASARCO Inc AR CMVT is added to the Communi cations Equipment COMMUNEQO grou
15. ot one of the standard indicators in TradingExpert Fortunately TradingExpert provides users with the ability to create indicators using the Expert Design Studio module To create an indicator we first need to create a User Defined Function UDF in Expert Design Studio To create a User Defined Function do the following Enter the Expert Design Studio and select File from the menu bar then New e To create a rule that calculates the difference between two moving averages type at the cursor oa SB Chews Chaat iea Wree Hales oe a Charts Ghat See hrc Help Figure 7 Ja ajeje Safe jejej as a aaa a ol Cib Beaded Fe Hod pra F D sje Gince High Lover Oper ema T MADif is ST MA IT MA e Save the file by selecting File from p e cst ea a S 8 a a al alia a E S a Pis Fah Chin ole Ca EDS apn EE LCF io Pot i Fea Hobs pars Fi the menu and then click Save We ll call the file MA Dif Note For more information on User Defined Functions see page 439 in the User Manual To create an indicator use the following procedure e Enter the Charts application Select Chart from the menu bar and click Settings Indicator Library and EDS Indicators The Custom Indicators screen that appears lists the EDS indicators that have been previously created Click Add to create anew EDS indicator Figure 7 In the Open dialog box op
16. p Harcourt General H will move from Retail Department Stores RETAILDE to Publishing PUBLISHI group NOVEMBER 1999 AIQ Opening Bell TOOLS OF THE TRADE THE RSI INDICATOR TRADINGEXPERT S wo APPROACHES EXPLAINED ew users of TradingExpert Pro may find it a bit confus ing that AIQ has two ver sions of the well known Relative Strength Index RSI indicator devel oped by Welles Wilder Before dis cussing the differences we ll first give some background on the indicator New technicians often assume the RSI indicator is a type of Relative Strength indicator That is a bit of a misnomer in that the indicator has nothing to do with Relative Strength which measures the performance of a security relative to other securities Instead the RSI indicator is an overbought oversold indicator and the only data needed for its calcula tion is the closing price of the security under study At the time of the development of the RSI most people looked at today s price of a security divided by the price x days ago to measure momentum Mr Wilder saw two problems with this calculation First this type of indictor can become erratic simply because of the numbers that are being dropped off Second this type of indicator can go up for quite some time without giving a clue as to what is really a high value A constant range of values was needed for comparison purposes RSI solves these problems by smooth
17. signal This signal was Fa Hes cas h confirmed on that day as the Phase indicator was decreasing The sell signal only lasted two days when a 99 buy signal was registered on October 14 This signal was not confirmed until October 20 when the Phase indicator increased in value An additional 95 buy signal came on October 22 Finally a 96 sell signal was registered on October 25 This signal came just before the market staged an impressive rally This is a case where confirmation helped weed out a bad signal By month s end the bee T signal was still unconfirmed For the month the best performing group is Software amp Processing The AIQ Pyramid software group contains high flying stocks such as Adobe Systems 2 Technologies and Veritas Software Overall the financial groups were the biggest winners gaining about 15 The worst groups were unchanged on the month and include Pollution Waste Management Casinos Heavy Machinery Chemi cals Commodity and Aluminum E The following table shows past and future stock splits and large dividends WestPoint Stevens Inc WPSN to Trading Suspended Stock Ticker Split Div Approx Date Stock Ticker Split Div Approx Date Genentech GNE 21 11 03 99 Ist Commonwealth Fin FCF 2 1 11 19 99 Sapient Corp SAPE 21 11 08 99 Timberline Software TMBS 4 3 11 22 99 Jakks Pacific JAKK 3 2 11 11 99 Veritas Software VRTS 3 2 11 22 99 King Pharmaceuticals KING 3 2 1
18. tor The following EDS code is highs but the MA Dif only matched its ADX is ADX ie to B a 50 day moving average previous high Another request is the ability to j ony oe Other simple indicators can be plot a moving average of an indicator MFis MnyFlow created For example people have For example the Money Flow indica AvgisSimpleAvge MnyFlow 50 expressed an interest in plotting the tor isa simple line By creating a UDF When creating this indicator using the above procedure select Two Fated Chats Figure 100E Lines in the Plot Type dialog box The le hee E a UDF called MF will plot the Money oe hin ules g mag aala sol E Flow indicator and the UDF called Avg will plot the moving average of Money Flow T a E ag iznine HiH Andrew al ahy hn Wire te aai t a eae Figure 10 shows Andrew Corp vl a i TT M rete f bem U witha 50 day moving average of he ih auii i al Money Flow Plotting a moving 5 average on Money Flow can help Hin My thy Ht lt L identify trend changes Also shown in E Me ane Figure 8 is the ADX indicator without 14 Sitka misal the ADXR line eo ae per TT 14177 User created indicators can not be mi ne ak 050 tested within the Expert Design Studio Money Flowsth a S0 dey Moving Average egg application For more detailed information on ew user created indicators see page 484 7 E rp 2400 l i in the User Manual E Meee a Pi f 16 00 m i Fra Halip pars F
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