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Lesson 5: Dr. Market Edge's Favorite Technical Indicators

The Second Opinion module contains fifty-seven technical indicators and studies. That's a lot to swallow even for the good Doctor. The following are my favorites and should be all you need to know to get the job done.

POWER RATING: The Power Rating is a proprietary indicator comprised of seven non-correlated technical indicators properly weighted so as to label stocks as being either in a strong or weak technical condition. Readings vary between -60 and +100. Plus 60 and higher is regarded as bullish and will trigger a Long Opinion, while readings of -27 and lower will generate an Avoid Opinion. As the Power Rating crosses zero, a Neutral Opinion is generated. A Long rating is a recommendation to Buy. No action is recommended on stocks with a Neutral rating, and stocks with Avoid ratings may be considered Short Sale candidates.

It is important to note whether the Power Rating is increasing or decreasing in value. A stock rated Long had a Power Rating greater than +60 at one time or the Long Opinion would never have been generated. As the Power Rating declines below +20 the technical condition of the stock is deteriorating and the odds are high that a Downgrade to Neutral will occur. Conversely, as the Power Rating of a stock rated Avoid increases to above -10 the stock is gaining strength and as the Power Rating crosses zero, it will be Upgraded to Neutral.

STOPS: Stops for stocks rated Long (Buy) are calculated by averaging the stock's most recent significant lows. This calculation generates a Sell Stop. Conversely, Buy Stops are generated by averaging recent significant highs for stocks rated Avoid. The logic behind this method of determining Stops is that previous highs and lows represent short-term resistance and support areas. The Stops are formulated in such a way that they follow the stock if it is moving in a profitable direction so as not to allow the position to give back its gains. If, however, the price moves against the position, the Stop remains the same until the position is stopped out. Users should consider penetration of the Stop to be an early warning of a change developing in the price trend of the stock.

U/D AND U/D SLOPE: A 50-Day ratio of a stock's daily Up-Volume to daily Down-Volume. This ratio is calculated by dividing the total volume on days when a stock closed up by the total volume on days it closes down. Readings of 1.0 and greater denote Accumulation (Bullish), while readings under 1.0 signal Distribution (Bearish). The Up/Down Volume Ratio Slope identifies the direction in which the Up/Down Volume Ratio is pointed. Although the raw U/D Volume Ratio is a valuable indicator, it is the direction or Slope of this indicator that forewarns of a change of trend in a stock's price.

STO SLOW %K & FAST %K (STOCHASTIC): Developed by Dr. George Lane, Stochastic indicators are designed to identify Overbought and Oversold conditions. The Stochastic Oscillator compares where a security's price closed relative to its trading range over x-time periods. Second Opinion computes both the Slow %K Stochastic Oscillator and Fast %K. Values range from 0 to 100. Readings over 80 signal Overbought conditions (short term negative) while readings below 20 are regarded as an Oversold situation (short term positive). Stochastic is best used to time entry and exit points.

SCORE: Score is a value between -4 and +4 and indicates whether the technical condition of the stock is improving or deteriorating. A score of -4 represents the worst extreme possible before the stock is Downgraded to Avoid while a score of +4 indicates the best level obtainable before the stock is Upgraded to a Long Opinion. It is suggested that you take defensive action if you are Long a stock and the Score deteriorates to -3 or -4. Conversely, if you short a stock take defensive action if the Score is +3 or +4.

The following back tested results used the Score to trade the stocks that are incorporated in the S&P 100 Index (OEX) over a 5 year period from 8/6/90 to 5/16/95. Four tests were performed for the Long side. Long positions were opened when a stock was upgraded to Long by Second Opinion. Positions were closed when the Score reached -1, -2, -3, and -4. The results are listed below.

Strategy Annualized % Return %Time Invested
Buy on upgrade to Long-sell when the Score is -1 9.5% 38.5%
Buy on upgrade to Long-sell when the Score is -2 15.2% 46.2%
Buy on upgrade to Long-sell when the Score is -3 23.0% 53.9%
Buy on upgrade to Long-sell when the Score is -4 25.1% 56.5%
S&P 100 9.6% 100.0%

The annualized percent return is the average annual return computed from the total profits and total capital required for the life of the test. The average annualized % return is calculated by taking the dollar amount of the largest transaction less any profits from prior transactions divided by the number of years in the test for each stock in the test. The percent time invested represents the time spent in open positions.

Notice that the results are much better if the position is held until the Score reaches -3 or -4. Not only does the annualized percent return increase, but the time invested increases also. When the Score reaches the lower values a greater degree of deterioration occurs before the position is exited. Of particular importance in this analysis is the % time invested. For example, opening positions when the Opinion was Upgraded to Long and closing when the Score reached -3 generated a 23.0% average annualized return while being invested only 53.9% of the time. Being fully invested in the S&P 100 Index during the same period would have generated a 9.6% annualized return.

 

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