technical analysis mag

Jan-M

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.technicalanalyst.co.uk wwwThe publication for trading and investment professionals

Market Outlook PollTechnical TradingMarket OutlookWe publish our first

poll for 2011Indicator focus onusing the MACD

Fibonacci targetsDow at 18,000

The Market Outlookfor 2011

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Jan-Mar 2011 THE TECHNICAL ANALYST 1

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Welcome

Matthew Clements Editor

After last years rally in stocks, there is increasing talk of an immi-nent correction, both in developed and emerging markets.However, views are mixed regarding the longer-term outlook,not only for stocks but also for commodities, most notably, oiland gold. In this issue we publish our first poll of analysts,traders and investment managers which we hope provides aguide to the broader view for the first half of this year.

We also introduce 20 Questions, a short and to-the-pointinterview with a leading trader or fund manager. PaulMumford of Cavendish Asset Management is our inductee.

We hope you enjoy this issue of the magazine.

OUT NOW!The Technical Analyst is proud to announce the publication of the third book in its Discussion Series."Technical Analysis in the Commodity, Energy, and Power Markets" features interviews with 12 marketanalysts and investment managers on their use and application of TA in their research and trading deci-sions. The book describes technical strategies that are uniquely effective in the commodity, energy, andpower markets with a focus on indicators, market correlations, and commodity trading strategies.

Price: 49.50 + P&PFormat: HardbackAvailable direct from the Technical Analystwww.technicalanalyst.co.uk/books

www.technicalanalyst.co.uk/booksThe Technical Analyst is published by Global Markets Media.

MARKET NEWS AND VIEWS 04

MARKET OUTLOOKSGold 07Fibonacci Targets Dow At 18,000 12Where Now for 2011? 16

SPECIAL FEATURE 21Market Outlook Poll 2011

TECHNICAL TRADINGIndicator focus 23Trading the Wedge Pattern 27Trading with Hursts Cyclic Theory 31

20 QUESTIONS 35Paul Mumford, Cavendish Asset Management

RESEARCH UPDATE 37

TRAINING DIARY 40


Jan-M

ar2

01

1

.technicalanalyst.co.uk wwwThe publication for trading and investment professionals

Market Outlook PollTechnical TradingMarket OutlookWe publish our first

poll for 2011Indicator focus onusing the MACD

Fibonacci targetsDow at 18,000

The Market Outlookfor 2011

COVER STORY 21Market Outlook for 2011We present our first annual poll plus a range ofviews and opinions from market experts for theyear ahead

07 The outlook for gold

35 20 Questions

27 Trading the Wedge Pattern

12 Dow Fibonacci target

Contents

4 THE TECHNICAL ANALYST Jan-Mar 2011

CitiFX released their first poll of global foreign exchange traders in late 2010. The survey found that 53%of those polled use a combination of fundamental and technical analysis in their trading with 36% usingonly technical strategies. Only 8% use solely fundamental analysis to trade.

MARKET NEWSAND VIEWS

Market News and Views

STRONG BUY SIGNAL FROM PRESIDENTIAL ELECTION CYCLE

Japans Nikkei 225 is on the vergeof surging by more than 50%according to Yutaka Yoshino, chieftechnical analyst at Nikko CordialSecurities. He says that long-termequity and FX cycles will convergefor the first time pushing the indexto 15,200 by mid-2012.Two stock-market cycles of 12

years and 60 years are about toconverge with an 11-year currencytrend. This means the yen is set topeak against the dollar before los-ing almost half its value, he said.The Nikkei rally may be the bestbuying opportunity in severaldecades he claims.

NIKKEI ON VERGE OFHUGE RALLY

TA MOST POPULAR AMONG FX TRADERS

2011 is the third year of the presidential cycle which is usually a positive yearfor stocks, according to The Fundamental Analyst on Seeking Alpha. Thetable below shows annual returns for the 3rd presidential cycle since 1951for the S&P500. They have been positive 15 out of 15 times with an averagegain of more than 18%. However, if the test period is taken back to (usingthe Dow as it has a longer history) 1931, the cycles record is still 18 out of20 with an average return of 13%. The long-term annual gain of the Dow is9% (excluding dividends).A closer look at the data also shows that the 12-month period beginning in

October of the second year of the presidential term has enjoyed averagetotal returns of more than 28 percent. For the current cycle, this periodbegan in October 2010.


Market News and Views

A new report by Andrew Clare and Stephen Thomas of Cass BusinessSchool in London says that trend-following rules enable investors to outper-form the indices across the range of asset classes. They add that a combi-nation of trend following and momentum based strategies can generatealpha on a consistent basis and reduce return volatility.Earlier research from the US into trend following strategies suggested that

applying them to the S&P500 for the period 1900-2008 would have generat-ed a return of 10.65% with a volatility of 12%. This compares with the indexsaverage annual return of 9.2% and volatility of 17.9%. The academics atCass says trend following outperformance can be accounted for because therules track the market when it is trending up and then switches to cashwhenever it is trending down. Also, the rules can be applied to a wide rangeof asset classes at the same time allowing for effective diversification.

Peter Geike-Cobb and PaulThursby of Thames River Capitalin London have warned thatemerging markets may be set fora nasty correction because ofvolatile capital inflows andpotential policy mistakes insome EM countries. They saythe risk of higher inflation meansUS government bonds and infla-tion linked assets are the obvi-ous alternative.

THAMES RIVER WARNS OFEM CORRECTION

US money manager Laszlo Birinyihas forecast the S&P500 willreach 2,854 on September 4,2013, Bloomberg has reported.His precise call represents a 322%rally from the March 2009 low of676. The bull markets that beganin 1962, 1982, 1990 and 2002suggest the current rally shouldcontinue for another 32 months,he said. He added that historyshows market rallies are greatestin the first and last quarters of bullmarkets; Q4 of the current rallymay start in July 2012 and gener-ate gains of 52%.

BIRINYI SEES 2013 HIGH IN STOCKS

Please email news stories to:[email protected] BBiirriinnyyii

BusinessWeek has reported TomDeMark, the US analyst andtraders famous for his DeMarkstudies, as saying US stocks areset for an immanent 11% correc-tion, at least. DeMark says hisSequential and Combo indicatorsare giving a sell signal for theS&P500 for the first time sincemid-2007. January 14th saw thefirst reversal signal for US stockssince March 2009 when the mar-ket rebounded strongly after a57% decline. He warned that thissignals a correction forJanuary/February that couldexceed 11% but it will be in multi-ples of 5.56% as market movesare typically multiples of this.

TOM DEMARK SEES STOCKS NEAR TOP

TREND FOLLOWING GENERATES ALPHA SAYS CASS

TToomm DDeeMMaarrkk

The Barrons Confidence Indexreached a new cycle high of82.6 at the end of January, upfrom mid-Jans 81. This figure isthe highest reached sinceautumn 2007. The index is ameasure of how the global bondmarkets are positioned. A risingindex indicates that investors aredemanding a lower yield despiteincreasing risk and so suggestsincreasing confidence in theeconomic outlook.

BARRONS INDEX AT NEW CYCLE HIGH


Market Outlooks

Golds phenomenal bull charge, over 468% since 1999, isnow starting to unwind after being tempered by a muletastandoff. Akin to traditional Spanish bullfighting, a muletaor small red cape is raised in order to tire the animals chargeand offer a beautiful display of faena. Gold has been locked in a critical standoff ever since it

carved out its all-time record high at $1431 and is currentlyshowing signs of rolling over. Point & figure charts highlighta price squeeze within a range between $1430 and $1320 (seeFigure 1). A break in either direction has the potential to drivea 20% change in the price of gold. The probabilities are nowskewed for an extended downside reaction.

The trend is your friend, untilC Nine-consecutive years of higher reaction highs and lowshave elevated gold to unique stardom within technical analy-sis records (see Figure 1). With such a high calibre breed ofbull, it would only be natural to believe that prices continueto run in a straight line. However, veteran market observersknow that such accelerated price moves, no matter howrobust, inevitably prove to be unsustainable in the shortterm. The aftermath of golds previous bull cycle, between1969 and 1980 (which has an 11-year time pattern that coin-cidentally mirrors the current secular uptrend that launchedin 1999 and peaked in late 2010), acts as an extreme, but

By Ron William

GGOOLLDDSS BBUULLLLCCHHAARRGGEE TTEEMMPPEERREEDD BBYY MMUULLEETTAASSTTAANNDDOOFFFF

Market Outlooks


Golds bull charge tempered by muleta standoff. By Ron William, MSTA, CMT, Technical Strategist at MIG Bank.

Golds phenomenal bull charge, which has risen over 468% since 1999, is now starting to unwind after being tempered by a muleta standoff. Akin to traditional Spanish bullfighting, a muleta or small red cape is raised in order to tire the animals charge and offer a beautiful display of faena.

Gold has been locked in a critical standoff ever since it carved out its all-time record high at $1431 and is currently showing signs of rolling over. Point & Figure charts highlight a price squeeze within a range between $1430 and $1320 (see Figure 1). A break in either direction has the potential to drive a 20% change in the price of gold. The probabilities are now skewed for an extended downside reaction.

The trend is your friend, until

Nine-consecutive years of higher reaction highs and lows has elevated gold to unique stardom within technical analysis records (see Figure 1). With such a high calibre breed of bull, it would only be natural to believe that prices continue to run in a straight line. However, veteran market observers know that such accelerated price moves, no matter how robust, inevitably prove to be unsustainable in the short term. The aftermath of golds previous bull cycle, between 1969 and 1980 (which has an 11-year time pattern that coincidentally mirrors the current secular uptrend that launched in 1999 and peaked in late 2010), acts as an extreme, but noteworthy omen to how markets can avalanche from mountainous peaks. (Note, golds prior bull market cycle made an annual closing low in 1969, then an intraday low in 1970, which closed up higher on the day).

Gold Point & Figure Chart ( Scale $10 x3 )

$1830 Target


Secondary Trend

1980 spike high

Primary Trend(45 degree-angle)

Key Level$1320

Muleta Standoff$1830 Target



Figure 1. Point & Figure chart illustrates the primary and secondary trend in gold and its current muleta standoffbetween $1430 and $1320. Chart insert (i) Annual candle chart exhibits nine-consecutive years of higher reaction highs& lows. Chart insert (ii) Gold bull-cycles past and present, mirroring 11-year time patterns. Source. Bloomberg L.P.

Market Outlooks

noteworthy omen to how markets can avalanche frommountainous peaks. (Note, golds prior bull market cycle made anannual closing low in 1969, then an intraday low in 1970, which closedup higher on the day).

A confluence of important exhaustion signals weregenerated by Tom DeMarks TD SequentialTM indicatoracross monthly, weekly and daily time frames (Figure 2).The daily chart highlights TD Sequential generated Red13 exhaustion sell signals on two different countdownswithin the current multi-month distribution pattern(head & shoulders/triangle). A break below $1320 wouldconfirm the reversal pattern and unlock an extendeddownside slide in gold. Further bearish evidence can also be seen on the monthly

chart which is currently developing a bearish engulfing can-dlestick pattern from the all-time record highs, following five

consecutive higher reaction highs and lows. A sustained breakbelow $1320 also completes a potential Primary degreeimpulsive third wave within an Elliott Wave structure. Thetendency for cycle alternation favours a sharp correctivefourth wave (opposite to the wave two sideways correction in2001), which would help develop an important low for 2011.This potentially offers a rare buying opportunity for what islikely to be the most profitable future rise in gold to come.

Demand Cycles and Speculative FlowsAll these headwinds have been further magnified by a tradi-tionally seasonal weak period (Figure 3), coupled with sharpunwinding from speculative activity (Figure 4). Gold demandcycles are generally weaker within the early months of theyear, following the summer to winter period when whole-salers typically build up inventory for the Indian wedding sea-son and end of year retail Christmas pickup. The COT chart (Figure 4) shows golds net position of

large speculators (Commitment of Traders), which is pre-dominantly made up of hedge fund liquidity. This measurehad pushed to all-time highs, marking an extreme reading inbullish sentiment as the investment community became fullycommitted to golds rise after it shattered through the all-important psychological $1000 barrier. However, COT readings are now sharply unwinding from

these extreme levels and approaching the lower side of itsbullish structural range. Over one and a half years of sizeablelong gold positions will be under threat once this structuralrange breaks. This would offer an attractive price vacuum

GOLDS PHENOMENAL BULL CHARGE,WHICH HAS RISEN OVER 468% SINCE1999, IS NOW STARTING TO UNWIND

AFTER BEING TEMPERED BY A MULETA STANDOFF.

Figure 2. Monthly, Weekly and Daily charts showing a confluence of exhaustion signals derived from Tom DeMarksTD Sequential indicator. The monthly chart also has Kase Dev stops overlayed for potential levels to take profits or exitpositions. Source. Bloomberg L.P.

A confluence of important exhaustion signals were generated by Tom Demarks TD Sequential indicator across monthly, weekly and daily time fractals (Figure 3). The daily chart highlights that TD Sequential generated Red 13 exhaustion sell signals on two different countdowns within the current multi-month distribution pattern (head & shoulders/triangle). A break below $1320 would confirm the reversal pattern and unlock an extended downside slide in gold.

Further bearish evidence can also be seen on the monthly chart which is currently developing a bearish engulfing candlestick pattern from the all-time record highs, following five consecutive higher reaction highs and lows. A sustained break below $1320 also completes a potential Primary degree impulsive third wave within an Elliott Wave structure. The tendency for cycle alternation favours a sharp corrective fourth wave (opposite to the wave two sideways correction in 2001), which would help develop an important low for 2011. This potentially offers a rare buying opportunity for what is likely to be the most profitable future rise in gold to come.

Figure 2. Time Fractals of Monthly, Weekly and Daily charts showing a confluence of exhaustion signals derived from Tom DeMarks TD Sequential indicator. Monthly chart also has Kase Dev stops overlayed for potential levels to take profits or exit positions. Source. Bloomberg L.P.

1

2

(1)

(2)

(3)

(4)

3 (5)

Kase Dev Stops(contracting)

Bearish Engulf pattern

Figure 3. Seasonality chart of Gold across 10-years; which highlights underlying weakness within the early months ofthe year and significant strength between summer and winter months. Source. Bloomberg L.P.

Demand Cycles and Speculative Flows

All these headwinds have been further magnified by a traditionally seasonal weak period (Figure 3), coupled with sharp unwinding from speculative activity (Figure 4). Gold demand cycles are generally weaker within the early months of the year, following the summer to winter period when wholesalers typically build up inventory for the Indian Wedding season and end of year retail Christmas pickup.

pecu

Figure 3. Seasonality chart of Gold across 10-years; which highlights underlying weakness within the early months of the year and significant strength between summer and winter months. Source. Bloomberg L.P.

The COT chart (Figure 4) shows golds net position of large speculators (Commitment of Traders), which is predominantly made up of hedge fund liquidity. This measure had pushed to all-time highs, marking an extreme reading in bullish sentiment as the investment community became fully committed to golds rise after it shattered through the all-important psychological $1000 barrier.

However, COT readings are now sharply unwinding from these extreme levels and approaching the lower side of its bullish structural range. Over one and a half years of sizeable long gold positions will be under threat once this structural range breaks. This would offer an attractive price vacuum for bears to seize control and anchor prices lower. Further deteriorating sentiment can also be found in the 20% fall across several Gold mining stocks, including Newmont, Goldcorp and Rand Resources (Figure 4 chart insert). All these charts

Seasonal Weakness

Seasonal Strength

10 year average

Market Outlooks


Figure 4. COT Net Large Speculator Positioning undwinding from all-time record highs and testing bullish structuralrange. Chart insert shows further deterioration in gold sentiment with a 20% correction across notable gold miningstocks. Source. Bloomberg L.P.

illustrate strong downside scope and imply that extended setbacks in gold are being actively priced into the market.

Figure 4. COT Net Large Speculator Positioning undwinding from all-time record highs and testing bullish structural range. Chart insert shows further deterioration in gold sentiment with a 20% correction across notable gold mining stocks. Source. Bloomberg L.P. Conclusion Golds primary trend remains intact, but even the strongest of bulls need to stop for a healthy rest. The muleta standoff is likely to leave an important signature on the precious metals roadmap and offer hard lessons to investors at large. To profit from golds awe-inspiring rise, we must first learn to respect the nature of its yin-yang behavior, just as a Torero would respect the beauty and tenacity of a raging bull. To do this we need to accept the markets highly volatile, double-edged, characteristics and enforce disciplined risk management. Astute trailing stop strategies such as Kase Dev Stops, help protect from sharp trend deviations and can provide short to medium-term profit taking opportunities. Watch for levels at $1240, $1181 and $1111 which are statistically calculated from golds current monthly true range. Any corrective setbacks are likely to be tentatively cushioned into the $1280-60 confluence zone (primary trend-channel support, 200-day MA, 61.8% Fib retrace) and $1220 (reversal pattern objective), with risk for an overshoot back to the July 2010 lows at $1157. This would be just shy of a 20% correction from the all-time record highs. These moves should provide bulls with adequate energy for another charge onto much higher altitudes. Remember that it will more than likely be golds strongest ascent, as characteristic of the fifth wave structure (the equivalent to Dows primary stage three, irrational exuberance, parabolic excess, within a long-term bull market cycle). Confirmation above $1500-20 (secondary uptrend ceiling), offers moves to $1830 (P&F target), with eventual acceleration to the next psychological glass-ceiling at $2000 and beyond. By this time, further tailwind will likely be offered by significant weakness on the US dollar as its major downtrend resumes and other fiat currencies continue to underperform. Moreover, the weak

Structural Level

for bears to seize control and anchor prices lower. Furtherdeteriorating sentiment can also be found in the 20% fallacross several gold mining stocks, including Newmont,Goldcorp and Rand Resources (Figure 4 chart insert). Allthese charts illustrate strong downside scope and imply thatextended setbacks in gold are being actively priced into themarket.

ConclusionGolds primary trend remains intact, but even the strongest ofbulls need to stop for a healthy rest. The muleta standoff islikely to leave an important signature on the precious metalsroadmap and offer hard lessons to investors at large. To prof-it from golds awe-inspiring rise, we must first learn to respectthe nature of its yin-yang behavior, just as a Torerowould respect the beauty and tenacity of a raging bull.To do this we need to accept the markets highly volatile,

double-edged, characteristics and enforce disciplined riskmanagement. Astute trailing stop strategies such as Kase DevStops, help protect from sharp trend deviations and can pro-vide short to medium-term profit taking opportunities.

Watch for levels at $1240, $1181 and $1111 which are statis-tically calculated from golds current monthly true range.Any corrective setbacks are likely to be tentatively cush-

ioned into the $1280-60 confluence zone (primary trend-channel support, 200-day MA, 61.8% Fib retrace) and $1220(reversal pattern objective), with risk for an overshoot back tothe July 2010 lows at $1157. This would be just shy of a 20%correction from the all-time record highs. These movesshould provide bulls with adequate energy for another chargeonto much higher altitudes. Remember that it will more thanlikely be golds strongest ascent, as characteristic of the fifthwave structure (the equivalent to Dows primary stage three,irrational exuberance, parabolic excess, within a long-termbull market cycle). Confirmation above $1500-20 (secondary uptrend ceiling),

offers moves to $1830 (P&F target), with eventual accelera-tion to the next psychological glass-ceiling at $2000 andbeyond. By this time, further tailwind will likely be offered bysignificant weakness onthe US dollar as its majordowntrend resumes andother fiat currencies con-tinue to underperform.Moreover, the weak rela-tive performance of keyasset classes and renewedincrease in the overallsecular uptrend acrosscommodities, driven byrising demand and inelas-tic supply, will compoundample scope for the bar-baric metal to stage itsgrand finale bullcharge.

CONFIRMATION ABOVE $1500-20OFFERS MOVES TO $1830 WITH

EVENTUAL ACCELERATION TO THENEXT PSYCHOLOGICAL GLASS-CEILING AT $2000 AND BEYOND.

Ron William is a TechnicalStrategist at MIG Bank


Market Outlooks

Market Outlooks


History and the Dow Only after the major crash in 1929(Figure 1 red line) and the burst of thedotcom bubble did the Dow decline to anew low after the end of the subsequent18 month period. The low occurredapproximately 34 months after the high.At present The Dow is 36 months sincethe high (brown line) and has passedwhere it experienced a new low in the1930s. So historically, nothing indicatesa double dip in equities. On the con-trary, if history should repeat itself, theDow could still rise 15-20% within thenext 2-3 months, with a further 30-50%rally within the next 2-3 years being adefinite possibility. Comparing the Dow during the eco-

nomic crisis in the 1970s with todaysmarket, they are very identical (Figure2). The picture clearly shows when psy-chology rules the market, i.e. duringpanics, movements in the market areidentical. On both occasions, the Dowperformed a corrective move to theFibonacci 0.618 resistance level within18 months from the time of the low. In1975-76 the Dow made an explosive

bullish move after taking out that resist-ance level a move that lifted it 15% inless than two months. The same has hap-pened to the Dow in the last quarter of2010.

Fibonacci projectionSo, whats next? We have looked backover the past 100 years of market move-ments to try and find possible targetsand/or resistance and support levels.Figure 3 is a log chart of the Dow since1920 and shows what the index has donewhen reaching important support andresistance levels since the crash in 1929and up to 2010. These are highlighted asblue lines with Dow values on the left.All these levels are in fact Fibonacci lev-els. We took the high in 1929 at 381.17and the low when the Dow made its alltime low in 1932 at 41.22 and thenmade a projection. Fibonacci levelsshown are: 0.5, 1, 1.382, 2, 3, 5, 8, 13, 21,34 and 55. If those levels have beenimportant in the past, the sameFibonacci levels are very likely to contin-ue to be important in the future. A new break above the resistance level

at around 11,600 would be followed by abreak above the 2007 high at around14,164. This could take it on to test the18,740 resistance level within the next 3-5 years. The threat to this target wouldbe a move below the support level ataround 7,180 and a break below the2009 low at around 6,470. Figure 4shows four extracts from Figure 3 thatillustrate how close the Dow was trading,and rejected/supported, at the levels thatare Fibonacci levels; levels that have theirbase in the 1929 peak - 1932 trough.

RSI supports bullish view The Relative Strength Index (RSI) inFigure 3 supports the bullish picture.Every time the RSI has been below 30(green circles) the Dow has undergone astrong recovery. Furthermore, when test-ed and rejected at the 40 level (purpleline), the index has resumed its bullishtrend. After the major bearish correctionin 2007-2008, where the RSI went below30, it has recovered quickly and is now setfor further gains and is close to test the 60level. A break above this will confirm abullish market.

FIBONACCI TARGETSDOW AT 18,000By Kim Cramer Larsson

A stock market correction historically lasts 12-24 months before reaching its ulti-mate low. By comparing the major corrections in the Dow and overlaying themtogether on the same chart, we can examine what is likely to happen in the future.

Market Outlooks


Market Outlooks


Figure 2: Dow today and in the 1970s

Source: Bloomberg

Source: Bloomberg

Figure 1: Dow overlayed major corrections since 1929

Figure 4: Four extracts from Figure 3.

1982 - 1994 1996 - 2010

1951 - 1962 1971 - 1986

Figure 3: Log chart of Dow since 1920

Source: Bloomberg


Market Outlooks

MARK HEWLETT, ANELLO ASSET MANAGEMENT

Which currencies currently offer the best opportunities? With Australian interest rates still much higher than those in the US and Japan, andwith no sign of that changing, more and more people will be dragged into the carrytrade, boosting the AUD.

To what extent is the euros existence under threat? Not at all, whether all members are still there in 2 years time is another matter but anyone leaving will onlymake the Euro stronger. With leading members of the ECB still hawkish by nature, currency debasement isnot on the cards, unlike the US, making the Euro a better bet in the longer term.

What is the best sentiment indicator to use for the FX markets? We feel the RSI is the best indicator for picking entry and exits with a number of other indicators includingcycle analysis and moving averages assisting trading decisions.

Is the USD in a long-term bear market? Yes, the only saving grace is it's still the reserve currency. This is an asset being actively devalued and thelong-term outcome is obvious although it won't be alone. You need to pick between the central banks look-ing to keep purchasing power against those that need to inflate debts away.

Do you consider the technical picture for the dollar? If so, what is your interpretation ofthe current picture? Taking the dollar index into account, it has recently broken below a number of recent support levels andlonger-term moving averages. The shorter-term moving averages are crossing below the longer-term movingaverages and momentum seems to be for a lower dollar. There doesn't seem to be much support until the76.25 area although there will of course be rallies which those that are nimble can take advantage of, shouldthey wish.

WHERE NOW FOR 2011?ASSET ALLOCATION FOCUS

We interview five money managers to assess their asset allocation and market outlooks for 2011 across the bond, equity, FX and commodity markets.


Market Outlooks

BEN BYROM, EXECUTIVE DIRECTOR, CENKOS CHANNELISLANDS INVESTMENT MANAGEMENT

What is your view on the timing of the first Fed or Bank of England raterise? This is a very difficult question to call. The steepening US yield curve implies thateconomic activity is improving, as is bank lending (albeit from a low base). Shouldthis trend continue, one would expect rate rises to start coming through sooner than investors are generallyexpecting. However, inflation data is still very poor and the recent rise in yields may turn out to be more ofa jitter in response to FED monetary policy rather than any concerted attempt to factor in higher rates.

What is your current outlook for the Euro, either technically or fundamentally based? At the time of writing Eurodollar is 1.3257. If we see a break below 1.2969, then I would expect a muchstronger USD against the Euro. As far as fundamentals go, you can pick any of Europes current issues asjustification.

How reliable do you think the yield curve is in implying future economic activity? The bond market supposedly reflects the real economy. However, its participants are still human and there-fore still susceptible to the same herd mentality as other markets. Interestingly, rates still rose despite theannouncement of increased purchasing by the FED suggesting that even Government firepower won'talways create the desired effect once the collective has made up its mind.

What is the best sentiment indicator to use for the bond markets? I keep an eye on the MOVE.

Do you consider the technical picture for these markets? If so, what is your interpretation ofthe current picture? Over-extended, over-hyped and overdone. At the time of writing, the Dow closed at 11,691.18. Given thedivergences between different market performances and declining breadth as indicated, for example, by mar-ket advance/decline ratios, some sort of correction is anticipated.

At the time of writing Eurodollar is 1.3257.If we see a break below 1.2969, then I would expect a much stronger USD

against the Euro.


Market Outlooks


LARS STEFFENSEN, EBULLIO CAPITAL MANAGEMENT

Which commodities currently offer the best opportunities? Based on good fundamentals and the attention of the investment community, wethink that copper, tin, platinum, palladium, corn, wheat, cotton and sugar look thebest and should benefit from both factors.

Is gold overbought/in a bubble? If not, how much further has it to go? Based on fundamentals, gold is definitely in a bubble a huge bubble. However, based on the slow death offiat money and the printing presses being red hot in the US, the UK and yes, in the Euro-zone, gold couldrun much further; remember that gold is the only accepted form of payment, that doesnt come with a hugedebt burden or pension liability attached.

What sentiment indicators do you use? We look at the usual key numbers, but our main sentiment indicator is volume; in the volume numbers youcatch what everyone is thinking in general and what the investment community is doing in particular. It isunusual to use volume, we know, but these are unusual times.

Are we entering another bull market for oil? Crude is a funny one given OPECs role as a cartel; however even OPEC couldnt keep us from $140 crude2 years ago. As long as interest rates stay low and the huge liquidity that infers, crude is in a bull market andcan go much higher demand is not going anywhere and whatever the price, crude will be consumed.Demand destruction is an urban myth.

Do you consider the technical picture for oil? If so, what is your interpretation of the currentpicture? The technical picture for crude is quite constructive; we believe that once $100 is broken we will resume thelong-term uptrend. Obviously, a breakdown caused by macro factors, such as the potential interest hikesmentioned above, will change that, but as long as we stay above 60, we think crude is safe.

The technical picture for crude is quiteconstructive; we believe that once $100 is broken we will resume the

long-term uptrend.

Market Outlooks

ROLAND NASH, CHIEF INVESTMENT STRATEGIST, VERNO CAPITAL

Are emerging markets stocks due for a large correction as recently sug-gested by Thames River? We think that emerging markets are due a substantive (10-20%) correction in thenear term in an otherwise well established bull market. They have run a long way,and they are now very much a consensus trade. Traditionally, that is dangerous.

Which emerging markets currently offer the best investment opportunities? Over the course of 2011, and expectations of a near-term Q1 correction notwithstanding, we think thatRussia and Kazakhstan can be among the best performing markets. They have underperformed since the2008 crisis, despite the superb recovery in commodity prices. We think higher economic growth, low domes-tic interest rates, attractive valuations and some well-signalled catalysts will drive a period of catch-uptowards the historic discount at which both markets tend to trade to general emerging markets.

What is the difference between frontier markets and BRICS as far as investment opportunitiesare concerned? Frontier markets generally offer lower liquidity and higher volatility, but not necessarily greater fundamentalrisk. That is the opportunity. BRIC is an acronym rather than an economic concept. The acronym has beenenough to attract substantially greater fund flows than other frontier markets, driving a valuation gap whichcan be arbitraged with the right analysis.

Is the high correlation between emerging markets a good thing? How can you decouple fromthis as an investor should you wish to? High correlation between emerging markets makes little economic sense, and therefore creates inefficiencies.It perhaps reflects some lazy thinking and the bunching together of a world of different risk-assets into acatch-all concept. This is unfortunate from an economic standpoint, but offers investment opportunities.The only real way to decouple is to take a longer-term view eventually the fundamentals will win out.

Do you consider the technical picture for emerging market stocks? If so, what is your interpre-tation of the current picture? Technical analysis is a minor part of our investment analysis, but we do use it to signal potential market tim-ing. In our view, the current picture does not look pretty for risk assets.


We think that emerging markets are due a substantive (10-20%) correction in the

near term in an otherwise well establishedbull market.

Market Outlooks

JOHN REDWOOD, CHAIRMAN OF INVESTMENT COMMITTEE, EVERCORE PAN-ASSET CAPITAL MANAGEMENT

What is your view on the timing of the first Fed or Bank of England raterise? The latest inflation figures in the UK led to more speculation that the Bank ofEngland could raise official interest rates sooner than most anticipated. RPI roseto nearly 5%, whilst the government's preferred CPI measure hit 3.7%. Meanwhile inflation fears even rosein the US, where there is much less reported inflation than in the UK, owing to the strength of the Chineseand other Asian economies and the recent buoyancy of commodity prices.

Are Eurodollar/Libor futures correctly priced given your view? If not, why?One of the best market guides we have are the futures markets, which think short rates will rise by early 2012in both the US and the UK. So far the UK has looked under more pressure to bring forward its first hikepost crisis, but the Governor of the Bank still says that he thinks current inflation is temporary and not par-ticularly susceptible to interest rate medicine.

How reliable do you think the yield curve is in implying future economic activity? The yield curves in both countries range from near zero at the short end of the low risk spectrum throughto nearly 4.5% for longer government bonds of 30 years or more. This is the best guess of the future wehave, implying more activity and some inflation ahead. The overall level of rates and the yield curve, how-ever, have been substantially affected by past quantitative easing programmes on both sides of the Atlantic,and by QE II in the USA. We remain unexcited by government bonds on these yields, and ever consciousthat at some point we are likely to return to more normal interest rate levels.

The yield curves in both countries rangefrom near zero at the short end of the low risk spectrum through to nearly

4.5% for longer government bonds of 30years or more.


Market Outlooks

We are pleased to publish our first semi-annual MarketOutlook Poll. It comprises the views of 300 technical analysts,traders and fund managers on their outlook for where six mar-kets in equities, FX and commodities will close at the end ofJune 2011. Whilst there are many market surveys available, we have

looked to take a longer-term measure of market sentiment andto try and identify any significant shift in sentiment as the yearprogresses. As such, we are not looking for precise forecasts butinstead where the aggregate view lies in terms of bullishnessand bearishness relative to the market today. In subsequent polls, we hope to incorporate more markets

and a wider range of contributors. In the meantime, we wouldlike to thank all those who took part in this poll.

Results summary

MARKETOUTLOOK POLL 2011

The Technical Analysts

Market Majority outlook

EUR/USD 1.25 - 140

GBP/USD 1.50 - 1.65

FTSE 5000 - 6000

DOW 10,000 - 11,500

OIL 80 - 100

GOLD 1,200 - 1,350

Special Feature


WHERE WILL EUR/USD CLOSE 30 JUNE 2011?

WHERE WILL THE FTSE CLOSE 30 JUNE 2011?

WHERE WILL GBP/USD CLOSE 30 JUNE 2011?

WHERE WILL THE DOW CLOSE 30 JUNE 2011?

WHERE WILL GOLD CLOSE 30 JUNE 2011?WHERE WILL OIL CLOSE 30 JUNE 2011?


Special Feature

The Moving Average Convergence-Divergence indicator(MACD), or Mac D as it is usually referred to, was devisedby Gerald Appel a US investment manager in 1977. It is oneof the most popular technical oscillators and uses a movingaverage crossover method to generate trading signals bymeasuring price momentum in trending markets. Like allmoving average-based indicators, the MACD is a lagging indi-cator.

Definition The MACD indicator consists of two lines:

MACD line - The 12-day EMA less the 26-day EMA Signal line - A 9-day EMA of the MACD line

The MACD is the difference between two exponentialmoving averages (EMAs), which are conventionally the 12-day and 26-day. The signal line is a 9-day EMA of the MACDline. It is this line that generates trading signals.

It is now usually for software packages to generate aMACD histogram on the same chart. This usually measuresthe difference between the MACD and signal lines.

MACDIINNDDIICCAATTOORR FFOOCCUUSS

THE

PLOTTED AROUND A ZEROLINE, A POSITIVE MACD

INDICATES THAT AVERAGEPRICES OVER THE PAST 12DAYS ARE HIGHER THAN

AVERAGE PRICES OVER THEPAST 26 DAYS.


Technical Trading

Trading signals Plotted around a zero line, a positive MACD indicates thataverage prices over the past 12 days are higher than averageprices over the past 26 days and so signal a bullish market(and vice versa). However, using crosses above and below thezero line is a crude and ineffective method of generatingtrading signals. Nevertheless, if the MACD remains above orbelow the zero line for long periods, this suggests that theunderlying market trend is either positive or negative so anycountertrend signals generate by the lines themselves shouldbe treated with caution. As usual with all technical indicators and oscillators, traders

should be aware of extreme readings, divergence with price, andtrends within the indicator itself i.e. descending peaks, risingtroughs and movement within channel lines. Trading signals are most commonly generate by the MACD

crossing above or below the signal line:

A cross of the MACD above the signal line - BUY A cross of the MACD below the signal line - SELL

Refinements of the MACD have been suggested byGunter, Albin and Kai (2001). They proposed ignoring very short-term trading signals by

waiting three days after a crossover before acting on the sig-nal (assuming no further crossovers happen in this time). Apre-determined trigger level is then set for the close of thethird day, for example 1%.

Trading signal = MACD Signal

Closing price

If the trigger level is set at 1% and the closes at the endof the third day are: MACD = 3, Signal = 1 and market =$100 then;

Trading signal = 3 1 = 2%

100

As this is greater than the 1% trigger levels, a buy signal isconfirmed.They also suggest setting a 3% or 5% profit taking rule

after a buy or sell signal in order to mitigate the lagging natureof the indicator. Their testing of the MACD used optimised parameters,

took no account of trading costs, and made no allowance formarket conditions when applying the MACD. However, theyfound that the MACD fails to outperform a buy-and-holdstrategy on G7 stock indices but does outperform on someemerging market indices. Zitzlsperger (2002) tested the MACD on the S&P500 and

found that using optimised parameters over a two year peri-od and applying those in trading over the third year producedsignificant returns before trading costs.

There have been a few academic papers on the MACD andits efficacy as a trading strategy. In a 2006 report Bill Huang(University of Leicester) and Yong Soo Kim (YonseiUniversity) found that the performance of the MACD can beincreased by changing the parameter settings, depending onthe market being traded. Meanwhile, Terence Chong(University of Hong Kong) found in 2008 that the MACDtested over a 60 year period on the UK stock market showedevidence of being able to produce higher returns than a buy-and-hold strategy.

What the experts say

Robert Colby in his Encyclopedia of TechnicalMarket Indicators says that backtesting on theMACD shows that the indicator is most effec-tive with longer-term trading strategies (withthe Dow) but over the short-term, is not profitable.

The MACD works particularly well in theFX markets. It allows you to enter tradeswith price momentum on your side.Christian Bendixen, Bay Crest Partners

The MACD indicator is a fantastic tool for identifying important price swings. The common parameters (13, 26 and 9 peri-od moving averages) can give signals that aretoo frequent on a daily bar chart, so I havebegun to use 21, 100 and 200 period movingaverages to capture more important intermedi-

ate-term shifts.Katie Stockton, MKM Partners

When I see a monthly MACD crossoverthat does not occur very often, say every fewyears, I pay attention. Same goes for the

monthly parabolic and double-top formationsthat tend to have lasting implications.

Jeff Hochman, Fidelity Investments


Technical Trading

Figure 2: Monthly EUR/USD Chart: Yahoo

Figure 1: Monthly Dow with MACD 9, 12, 26 Chart: Yahoo

Market examplesFigure 1 shows the Dow from February 2009 to July 2010.This period saw the low in March 2009 and subsequent rallyto a high in April the next year. The MACD produced a buysignal in March as the MACD line (blue) crossed above theSignal line (red). The short-lived correction in June 2009 wasalso signalled by an MACD sell.

Figure 2 shows a EUR/USD chart from January toOctober 2010. As can be seen from longer-term charts,clear MACD signals dont happen that often. However, abuy signal in June captured most of the subsequent rally inthe euro to August.


Technical Trading


Technical Trading

The wedge is a pattern which can befound on every timeframe, frommonthly charts to intraday price action.There are two sorts of wedges:

Falling wedges; they mostly com-plete after a sharp slump in pricesand are a bullish

Rising wedges; these usually comebefore a violent downwards reversal.Their bearish bias is all the morepronounced since they are complet-ed after a long period of time fol-lowing a clear uptrend.

As a general rule, continuationwedges tend to complete more quicklythan reversal wedges. Even if a wedgeacts a continuation pattern, the basicrules still apply: breakouts happendownwards for a rising wedge


TTRRAADDIINNGGTTHHEE WWEEDDGGEEPPAATTTTEERRNN

Technical Trading

By Yann CORDIER

Rising wedge

Falling wedge

(bearish) and upwards for a fallingwedge (bullish). Over the longer-term, falling wedges

are more seldom encountered than tra-ditional reversal patterns like invertedhead-and-shoulders structures or dou-ble/triple bottoms, but they remainexcellent forewarnings of the end of adowntrend.

Pattern construction and basic principles Unlike flags and rectangles, a wedge hastwo converging straight lines, a supportline and a resistance line. Both linesslope either up or downwards. We con-

sider that support and resistance linesmade by only two points are enoughfor a wedge to qualify. A rising orfalling wedge can extend itself until itsapex. All the examples of wedges I use aredaily charts using open/close pricesrather than extreme points reachedduring the session. This makes thecharts cleaner during volatile sessions.

Figure 1 is a Nokia chart that shows agood example of an intraday risingwedge. Noice the divergence made bythe slow stochastic oscillator at the endof the pattern. Although usually considered a rever-

sal pattern, the wedge can also act as acontinuation pattern. Figure 2 shows aperfect example of continuation risingwedge pattern from the Topix in 2007.

Inherent risks to wedgesThe wedge pattern's success rate, as a% of bearish/bullish breakouts for arising/falling wedge, is high, but trad-ing wedges accurately is a tricky task.How can this paradox be explained?The main reason is the difficulty in

forecasting the timing of breakoutsbecause of the patterns irregularity.For example, a trader thinks priceshave broken the lower trendline of arising wedge so he bets on a sharpdown move to come. However, wedgesare especially vulnerable to whipsaws. In the case of our rising wedge

(Figure 1), should prices manage toreach the former lower support line which now acts as a resistance line again, the mistakes to avoid are notonly the cutting of freshly initiatedshort position, but also in going longagain. If a pullback occurs followingthe breakout of a rising wedge (whip-saw) it is appropriate to:

Partly neutralise a short position

Re-draw a less steep lower supporttrendline to take the supposedly falsebreakout into consideration,

Reinitiate a short position once thisnewly drawn trendline is broken tothe downside. For more safety, onecan also rely on technical indicators,or volume, and ideally on bearishdivergences as we will examinebelow.


Technical Trading

Figure 1: Nokia Rising wedge reversal

Figure 2: TOPIX 2007 Wedge continuation pattern

UNLIKE FLAGS AND RECTANGLES, A WEDGE HAS TWO CONVERGING STRAIGHT LINES, A SUPPORT LINE

AND A RESISTANCE LINE.

Price targetsFrom our own experience, we aretempted to say that from a wedgebreakout, prices tend to go almostalways in the expected direction.Moreover, the duration of their com-pletion before the breakout is generallya forerunner of the future trend's mag-nitude: a particularly long rising wedgemostly warns you of a sizeable bearishmovement to come. Another difficultylies in determining a price target. Unlikeother patterns such as triangles andhead-and-shoulders, which have reliabledeterminants of a price target, wedgesfrequently encompass false and/or mul-tiple breakouts, leading to the need toadjusting trendlines. If the wedge looks to be a continua-

tion pattern, for instance a falling wedgeafter a clear bullish trend, then one cancalculate the extent of the movementprior to the pattern and extrapolate it tothe upside once the wedge is broken,exactly as if you were studying a flag ora pennant. If, on the other hand, youanticipate that the wedge will be a rever-sal, such measures are inefficient.Fibonacci-like retracements providebetter price targets in this case.

Asymmetrical behaviourHuman psychology suggests that mar-ket lows are made at the conclusion oflonger periods. That is why reversalfalling wedges take even more time tocomplete than reversal rising wedges.After prolonged pessimism in the mar-ket, we strongly advise against anticipat-ing any upside breakout in a fallingwedge, except when it occurs within anocean of bad news. It is well knownthat markets that dont react to morebad news are probably poised for abounce. Figure 3 shows a falling wedge

with bullish reversal implicationsplotted in the 1993 chart ofJPYUSD. Notice that its supportline is only propped up by twopoints. With the benefit of hind-sight, we can see that it was better towait for the short pullback a fewdays after the pattern's completion(green arrow) before going long.

Figure 3: JPY/USD 1993 Falling wedge reversal pattern


Technical Trading

Figure 4: S&P500 in 1987 - Falling wedge reversal and the MACD

WHEN ANALYSING WEDGES SCRUTINIZING VOLUME IS ESSENTIAL.

VOLUME CAN HELP REMOVE ANY AMBIGUITY AS TO WHETHER THE

CURRENT CONSOLIDATION PATTERN IS ANASCENDING TRIANGLE OR A RISING WEDGE.


Technical Trading

ValidationAs usual in technical analysis, it is bet-ter to check a patterns validity usingadditional techniques. An Elliott Wavestudy is a great help here as continua-tion wedges abound in waves 2 and 4.Wedges can be also found in waves 5;in this case, they form all of them andare essentially reversal warnings.Conceptually, they perfectly coincidewith the exhaustion situations inher-ent in most of waves 5: new highs aremade (in the case of a rising wedge)but in a more painstaking way withcontracting volumes and shrinkingvolatility.

Volume analysisWhen analysing wedges scrutinizingvolume is essential. Volume can helpremove any ambiguity as to whether thecurrent consolidation pattern is anascending triangle or a rising wedge. Ina rising wedge, volumes reached oneach successive high will tend todecrease. In an ascending triangle, vol-umes will be greater on up days than ondown days. While diminishing volumesduring up waves in a narrow range are aserious warning of bearish reversal, theopposite signal after extended slumps isfar more complex to analyse.

OscillatorsThe use of technical indicators isanother method of avoiding false sig-nals from wedges. They can not only

avoid whipsaws but can also help withthe timing of trade entries and exits. Asa simple rule, momentum indicatorswork best with reversal wedges andtrend following indicators best withcontinuation wedges. For reversal wedges, the slow stochas-

tic is particularly effective in trackingdivergences between prices and theindicator, generating signals fromcrossovers of the %D and %DS lines,and for generally monitoring exits fromoverbought/oversold areas. The MACD is also a very useful indi-

cator in supporting a wedge pattern.Figure 4 shows US stocks after the 1987stock crash. This gives a perfect exam-ple of a reversal falling wedge whichcoincides with a very clear bullish diver-gence between prices and MACD.

Trading rules

Timing: For a wedge, timing abreakout is tricky because unlike tri-angles, you dont have a deadline forthe completion of the pattern. Witha wedge, it may well last until itsapex, without being invalidated.

Breakouts: A breakout may be afalse signal so look for confirmationwith prices moving, for example, twocandles out of the wedge. Look atvolume and technical indicators togauge the degree of price conviction.If volume fails to follow price thenthe possibility of a breakout increas-

es. In this case, you should add astop-loss a few points below the for-mer breakout level after a risingwedge.

Price targets: Do not assign anyprice target just based on the pattern.Even though targets are easier todetermine in the case of continua-tion wedges (by extrapolating), theyare not outstandingly efficient fromour experience.

What if our wedge is invalidated?In the case of wedges, we need sometolerance. False breakouts areextremely frequent and often requirethe redrawing of the steepest trend-line once or more. Again, watchingvolumes is crucial when it comes toweighing the odds of a false break-out.

Finally, a major stop level, taking theinvalidation of the wedge into account,should obviously be set but this pointmust be chosen clearly above (below)the high (low) reached during the rising(falling) wedge. Don't forget: room tomanoeuvre should be greater than forany other chart pattern. If you workwith daily data, we suggest you replacethe high/low with the highest/lowestclose reached during the wedge.

Yann CORDIER is a portfolio man-ager in European equities at AXAInvestment Managers in Paris.

Introducing JM Hurst the Father of Cyclic AnalysisJM Hurst was an American aeronautical engineer who pro-posed a cyclic theory about the workings of financial marketsin the 1970s. He is considered by many to be the father ofcyclic analysis and has published two seminal works: a bookcalled The Profit Magic of Stock Transaction Timing and a fewyears later a workshop-style course which was called theCyclitec Cycles Course (now available as JM Hursts CyclesCourse). It is in the Cycles Course that the full theory isexplained in great detail.

Hursts Cyclic TheoriesHurst defined eight principles which provide the definition ofhis cyclic theory. The principles are:

The Principle of CommonalityAll freely tradable markets exhibit price movementswhich have much in common.

The Principle of CyclicalityPrice movements consist of a combination

of specific waves and therefore exhibit cyclic charac-teristics.

The Principle of SummationPrice waves which combine to produce the price move-ment do so by a process of simple addition.

The Principle of HarmonicityThe wavelengths of neighbouring waves in the collec-tion of cycles contributing to price movement are relat-ed by a small integer value.

The Principle of SynchronicityWaves in price movement are phased so as to causesimultaneous troughs wherever possible

The Principle of ProportionalityWaves in price movement have an amplitude that is pro-portional to their wavelength.

The Principle of NominalityA specific, nominal collection of harmonically relatedwaves is common to all price movements.

The Principle of VariationThe previous four principles represent strong tenden-cies, from which variation is to be expected.

Trading withHursts CyclicTheory


Technical Trading


Technical Trading

In essence these principles define a theory which describesthe movement of a financial market as the combination of aninfinite number of cycles. These cycles are all harmonical-ly related to one another (their wavelengths are related bysmall integer values) and their troughs are synchronisedwhere possible, as opposed to their peaks. In other words, thetrough of each cycle always occurs at the same time as atrough of all smaller cycles. The principles define how cyclescombine to produce a resultant price movement.These simple rules distinguish Hursts theory from any

other cyclic theory. For instance most cyclic theories consid-er cycles in isolation from each other and cycles are oftenseen to disappear. By contrast, cycles never disappearaccording to Hursts theory, but they may be less apparentbecause of the way in which cycles combine. It is the fact thatHursts theory stipulates that there are an infinite number of

cycles that makes it particularly different and also begins toexplain why it is impossible to forecast price movement with100% accuracy. Just as it is impossible to conceive of the sumof two infinite numbers, it is impossible to define the resultof combining an infinite number of cycles.

Phasing AnalysisThe true genius of Hursts theory as presented in the CyclesCourse was in the way that he proposed an analysis should beconducted. The analysis is called a Phasing Analysisbecause it is a matter of determining the current phase of asmany cycles as possible. Hurst advocated a process which issimple in essence and is based on a form of pattern recogni-tion by eye. This method differs from the approach he pre-sented in the Profit Magic book which was purely mathe-matical in that it required the plotting of a displaced movingaverage (inflated to create channels around price the wellknown Hurst envelopes).

The pattern recognition approach involves identifying themajor troughs of the longest cycle that appears to be presentin the data (Hurst called this the dominant cycle). If a partic-ular expected trough is not apparent, or there is ambiguity inthe positioning of the trough, the resolution of this trough ispostponed until the analyst has more detailed information.One then considers the next shorter cycle in the cyclic modeland identifies the troughs of that cycle using the previouslypositioned troughs of the longer cycle as anchoring points.The positioning of shorter cycle troughs often resolves thepositioning of the longer cycle troughs and so the analyst isconstantly moving between the cycles, but generally movingfrom the longest (dominant) cycle down to the shortest cycle. Having performed a phasing analysis, the results are plot-

ted on a chart using a notation system proposed by Hurst,involving the placing of diamonds beneath the price to rep-resent the troughs of the various cycles. And then one moveson to the second aspect of Hursts theory: making tradingdecisions on the basis of the cyclic analysis.This aspect of Hursts theory is once again distinguished

from other cyclic theories. Most cyclic theories advocate

Figure 1: An example where six cycles have been identified andhave combined according to Hursts principles to produce acomposite price movement. The green arrows represent buy-ing points at the troughs of the yellow cycle. Price movementout of the trough (and trade potential) is different for eachtrough because of the underlying trend.

THE PATTERN RECOGNITIONAPPROACH INVOLVES

IDENTIFYING THE MAJORTROUGHS OF THE LONGESTCYCLE THAT APPEARS TO BE

PRESENT IN THE DATA.


Technical Trading

buying a market when the cycle is rising, and selling when thecycle is falling. Hursts trading methodology on the otherhand takes into account the fact that price is the result of acomposite of many cycles and only advocates buying when acycle is rising and the two cycles longer than the trading cycle(in the harmonic collection of cycles) are also rising. Similarlyone should only sell (go short the market exits are a differ-ent matter) when the two cycles longer than the trading cycleare also falling. There are further guidelines to be observedbefore selling short, because of the principle of synchronici-ty which tells us that troughs are synchronised and there-fore much easier to trade whereas peaks are not synchro-nised and are therefore more complicated to identify andmuch more difficult to trade.

Timing Trade Entries and ExitsBeyond the above overall guideline as to when one shouldenter the market, trading according to Hursts cyclic theo-ry requires that one times ones trading actions by meansof using two cyclic tools: the FLD (Future Lines ofDemarcation) and the VTL (Valid Trend Line). The FLD (Future Line of Demarcation) of a particular

cycle is calculated by transposing the median price byroughly half the wavelength of the cycle in question intothe future.The VTL (Valid Trend Line) of a particular cycle is a

trend line which joins two consecutive troughs or peaks ofthat cycle (as seen in the price movement), and then fur-ther validated by obeying a few simple rules defined byHurst.These tools provide evidence of a cyclic nature that a

trough or peak of a particular cycle has occurred and sothey are used to create what Hurst called action signals when price crosses an FLD or VTL a signal is generat-ed, whereupon one should take an action (such as buyingor selling).

A Note on Intraday TradingIt is a feature of Hursts cyclic theory that cycles movethrough time, regardless of whether we are trading finan-cial markets or not. A cycle keeps moving through theweekend. When analysing daily data this is not much of aproblem, but when analysing intraday data it becomes afairly big problem. On a Monday morning one is facedwith a gap of over 60 hours in most markets, duringwhich time there would have been a good deal of cyclicactivity. There would have been 7 or 8 full waves of the 8hour cycle, and if that cycle is your chosen trading cycle,Mondays present an interesting challenge: it will usuallytake several hours to identify the current phasing of the 8hour cycle.

David Hickson is founder of Sentient Trader, a pro-gramme designed to perform Hurst Cycle phasinganalysis and identify trade opportunities based on HurstCyclic theory. See www.sentienttrader.com

Figure 2: EURUSD with a cyclic analysis presented in Hurstsdiamond notation. Each diamond represents a trough of acycle. As of the 7th of January 2011 a trough of the 80-day cycleis expected (it has been 84 days since the previous trough). The40-day VTL and 80-day FLD are plotted.

Figure 3: EURUSD in more detail. An hourly chart with theFLDs of the 40 hour, 3 day and 5 day cycles plotted, and theVTL of the 40 hour cycle. These lines provide good entry levelsfor trading the move out of the expected 80 day trough. Thevertical dashed line represents the time at which trading willcommence on Sunday night.

Figure 4: On Monday morning (10th January 2011) the marketstarts rising out of a trough and a long entry is effected at alevel determined by the 2-day FLD. A stop-loss exit is posi-tioned according to cyclic principles.


20 Questions

1. If today you had to invest your entire fund in one market for a period of 12months, which market would you choose? Given my history with and specialism in the UK market, Id have to say the UK. But if I had to invest elsewhere right nowId say Japan.

2. If today you had to invest your entire fund in one market for a period of onemonth, which market would you choose? Same as above if not the UK, Japan.

3. Was the scare over the credit crisis and global economy overdone by the mediaand financial commentators?Not necessarily, although of course being a newsworthy subject a fair degree of time was, inevitably, spent on it.

4. Are more banks going down?No, but at least one football team beginning with the letter W will.

5. Whats best and why; growth, value or momentum investing? At the bottom of the market cycle you can find value in growth, whilst at the top of the cycle growth can be overvalued. Atboth points momentum can be a useful guide in determining the timing of entrances and exits.

6. If you are restricted to using only one technical/chart indicator, what would you choose? Conventional charts to determine trends, resistance, and support levels are all helpful in timing buys and sells.

7. What separates a great fund manager from a mediocre one? The stocks he picks.

20 Questions


8. If a manager has had 5 good years in a row, do you carry on investing in him orpull out? I dont invest in other managers products. If the manager is me, carry on.

9. Does traditional equity analysis provide any value, if so, what?It provides value in determining the cheapness or otherwise of a given stock, particularly when it comes to hidden asset sit-uations.

10. If you could employ either an economist or technical analyst, which would youchoose? An economist, reluctantly.

11. Is BRICS as an investment opportunity still alive and well? Quite possibly.

12. Are frontier markets a cause for excitement? Possibly, though these are not my areas of specialisation.

13. When will be the first rate rise from the Fed? Sometime in the later part of the current calendar year.

14. What was the last business book you read and how would you rate it? Ive never read a business book in my life.

15. Which analyst (of any sort) do you respect and follow closely?I dont follow any particular analysts closely.

16. Is gold near its peak and how much further has oil to go? Gold looks to be consolidating, but oil is likely to go higher, though how high I couldnt say.

17. Is the euro destined to fail within the next few years?Personally, I would hope so. Though in terms of the fund and market volatility, hopefully not.

18. Stocks: are we in a secular bear or bull market? Were in a bull market currently, and there is a lot of value in stocks.

19. Bonds: are we in a secular bear or bull market? Seeing as interest rates are almost certain to rise this year, we are likely to enter a bear market.

20. Overall, will 2011 be better or worse than 2010? Provided Im still alive at the end, it will be better than 2010.


20 Questions

Research Update


LOW LEVERAGEDCOMPANIES OUTPERFORMGulnur Muradoglu and Brian Baturevich of Cass BusinessSchool have investigated the ability of company capital struc-tures to be used as a predictor for abnormal returns. They showthat companies in the lowest leverage decile, exhibit the highestabnormal returns (17%) over a three-year period, controlling forsize of company, price-to-earnings (PE) ratio, market-to-bookvalue ratio and beta. A strategy of choosing the smallest compa-nies with the lowest leverage yields cumulative abnormal returnsin excess of 80% over three years.

Muradoglu, Yaz Gulnur and Baturevich, Brian, Would You Follow MMor a Profitable Trading Strategy? (October 1, 2010). Frontiers in Financeand Economics, Vol. 7, No. 2, 69-89, October 2010.

A LONG-TERMPERSPECTIVE ONSEASONAL PATTERNSOver 300 years of UK stock returns reveal that well-knownmonthly seasonal patterns are sample specific, according to BenJacobsen and Cherry Yi Zhang of Massey University. For exam-ple, the authors point out that the January Effect only emergesaround 1830, which coincides with Christmas becoming a pub-lic holiday. Most months have had their 50 years of fame, show-ing the importance of long time series to safeguard against sam-ple selection bias, noise, and data snooping. Only monthly Julyand October effects persist over three centuries, as does the halfyearly Sell-in-May effect. Winter returns November throughApril are consistently higher than (negative) summer returns,indicating predictably negative risk premia. A Sell-in-May trad-ing strategy beats the market more than 80% of the time over 5year horizons.

Jacobsen, Ben and Zhang, Cherry Yi, Are Monthly Seasonals Real? AThree Century Perspective (October 25, 2010).

A BOLLINGER BANDSTRATEGY FORFUTURESA team of researchers from the University of Malaya haveinvestigated the use of a Bollinger Bands Z-Test trading rule onfutures prices. They find abnormal returns over and above thatgenerated by a passive buy-and-hold policy for FKLI, FCPO,Soyoil, Soybean and Corn futures. Their model captures largeprice movements which happen beyond 1 standard deviation.The mechanical buy signal is above 1 standard deviation and sellsignal is below 1 standard deviation. For the period12/15/1995-12/31/2008, the strategy yields a return of 1,048.6points for FKLI in comparison to the passive buy-and-hold pol-icy which yields a negative return of 110.5 points. The returnsobtained for FCPO, Soyoil, Soybean and Corn futures for theyear 2008 are 1,119, 27, 522 and 328 points respectively.

Azizan, Noor Azlinna and Phooi Mng, Jacinta Chan, Can TechnicalAnalysis Predict the Movement of Futures Prices? (September 2010). TheIUP Journal of Financial Risk Management, Vol. VII, No. 3, pp. 57-74, September 2010.

IS PAIRS TRADINGSTILL PROFITABLE?Two Australian researchers have examined the impact of prof-itability of pairs trading in the US equity market over the period1963-2009. After controlling for commissions, market impactand short selling fees; they find that pairs trading remains prof-itable, albeit at much more modest levels. Specifically, they doc-ument a risk-adjusted return of about 30 bps per monthamongst portfolios of well matched pairs that are formed with-in refined industry groups. Strategies that are implemented onthe top 30% largest stocks produce an average alpha of 19 bpsper month. The authors conclude that pairs trading exhibits alower risk and lower return profile than a short-term contrarianstrategy that sorts stocks relative to their industry peers.Another study has investigated the profitability of a self-

financing pairs portfolio trading strategy in the Finnish stockmarket under different weighting structures. Over the period1987 to 2004, they find pairs trading to be profitable even afterallowing for a one day delay in the trade initiation after the sig-nal. On average, the annualized return can be as high as 15%.The authors say the profits are not related to market risk and afully invested pairs trading strategy is found to produce positivealpha during the sample period.

Do, Binh Huu and Faff, Robert W., Are Pairs Trading Profits Robustto Trading Costs? (November 5, 2010). Broussard, John Paul andVaihekoski, Mika, Profitability of Pairs Trading Strategy in Finland(December 21, 2010).

GAMBLING NATIONS ANDSTOCK MARKET BEHAVIOURA US-based team of researchers havelooked at whether gambling activities ofinvestors induce excess comovements instock returns. Using a religion-basedproxy for gambling propensity, they showthat return comovements are strongeramong stocks that are located in regionswhere people are more prone to gamble.In particular, gambling motivated tradinginduces strong comovements among low-priced stocks, local stocks and lottery-

type stocks. Gambling-induced comove-ments are amplified when lottery ticketssales are high, when local investors havepositive income shocks, and followingstock splits. Overall, the evidence indi-cates that gambling is a common sourceof comovements in stock returns.

Kumar, Alok, Page, Jeremy K. and Spalt,Oliver G., Gambling and Comovements(December 16, 2010).

MOMENTUM ANDSEASONAL MEANREVERSIONChelsea Yao of the University ofMelbourne has found that momentumand seasonality profits are time-varying.Momentum profits seem to be closelyrelated to market conditions, being bare-ly profitable during crises, whereas sea-sonality does not have such a strong rela-tionship with market conditions.

Yao, Chelsea Yaqiong, Momentum, Seasonalityand January (December 30, 2010).

Information Flow andMarket ImpactAre investors less attentive to information arriving continuously in small amounts thanto information with the same cumulative stock price implications arriving in largeamounts at discrete timepoints? This is the hypothesis of an international team ofresearchers who think a series of gradual frequent changes attracts less attention thaninfrequent dramatic changes. When tested, they found strong evidence that continuousinformation induces stronger and more persistent return continuation. Over a six-month holding period, momentum decreases monotonically from 8.86% for stockswith continuous information to 2.91% for stocks with discrete information. Highermedia coverage and higher analyst coverage are associated with more discrete and morecontinuous information, respectively.

Da, Zhi, Gurun, Umit G. and Warachka, Mitch, Frog in the Pan: Continuous Information andMomentum (January 05, 2011).


Research Update

Superior Analysts MakeLong-Term Forecasts Even though the expected growth offuture earnings plays a vital role in invest-ment analysis, not all analysts producelong-term earnings growth forecasts.Andreas Simon of California PolytechnicState University and John Nowland ofCity University of Hong Kong haveexamined whether the issuance of long-term growth forecasts by analysts is a sig-nal of analyst quality. They find that ana-lysts who issue long-term growth fore-casts have better forecasting ability, moreexperience and more private information.

Furthermore, a forward-looking tradingstrategy that follows the stock recom-mendations of analysts that issue long-term growth forecasts earns 4-factoradjusted abnormal returns of 1.33 per-cent per month higher than a tradingstrategy following the recommendationsof analysts that do not issue long-termgrowth forecasts.

Simon, Andreas and Nowland, John, Do Long-Term Growth Forecasts Signal AnalystQuality? (October 25, 2010).

Jumps in BondPrices SignalExcess ReturnsA team of researchers from RobecoAsset Management and ErasmusUniversity Rotterdam have built on pre-vious work that shows that the meanaverage jump in bond prices can predictexcess bond returns. They show thatthese jumps often take place at 8:30 and10:00, directly linking them to specificmacroeconomic news announcements. Itappears that excess returns are related tomacroeconomic announcements thatmatter to market participants and jumpsare a good market proxy for whatinvestors believe is important news.Their improved jump measure producesa Sharpe ratio of 0.52 in an out-of-sam-ple market-neutral investment strategy.

Duyvesteyn, Johan G., Martens, Martin P.E.and Safavi Nic, Siawash, Forecasting BondReturns Using Jumps in Intraday Prices(November 28, 2010).

STOCK MARKETINTEGRATION LOWER ONFRIDAYS AND MONDAYSHow independent are each of the fourmain US stock market indices? GuglielmoCaporale of Brunel University and LuisGil-Alana of the University of Navarrahave examined the degree of integrationof the Standard and Poor, Dow Jones,Nasdaq and NYSE, at a daily frequencyfrom January 2005 to December 2009.Their results indicate that the four seriesare highly persistent; a small degree ofmean reversion (i.e. orders of integrationstrictly smaller than 1) is found in somecases for S&P and the Dow Jones indices.The most interesting findings are the dif-ferences in the degree of dependence fordifferent days of the week. Specifically,lower orders of integration are systemat-ically observed for Mondays and Fridays,consistent with the day of the weekeffect frequently found in financial data.

Caporale, Guglielmo Maria and Gil-Alana,Luis A., The Weekly Structure of US StockPrices (November 15, 2010). CESifo WorkingPaper Series No. 3245.

Technical TradingRules in EURUSDStephan Schulmeister of the Austrian Institute of EconomicResearch has investigated 1024 moving average and momentummodels in EUR/USD (and prior to the Euro, USD/DEM)based on daily data. His main results are: First, each of thesemodels would have been profitable over the entire sample peri-od. Second, this profitability is exclusively due to the exploita-tion of persistent exchange rate trends. Third, the results do notchange substantially when trading is examined within subperi-ods. Fourth, the 25 best performing models in each in-sampleperiod examined were profitable also out of sample in mostcases. Fifth, the profitability of technical trading in the curren-cy pair has been significantly lower since the late 1980s as com-pared to the first 15 years of the floating rate period.

Schulmeister, Stephan, Components of the Profitability of Technical CurrencyTrading (2005). WIFO Working Paper No. 263.

Research Update


TREND FOLLOWING VS CONTRARIANSeveral papers have looked recent at thequestion of what is a more effectivekind of trading strategy: trend followingor contrarian? James Kozyra andCamillo Lento of Lakehead Universityin Canada have found that, after adjust-ing for transaction costs, the contrarianapproach consistently outperforms thetrending approach, and is able to earnreturns in excess of the buy-and-holdtrading strategy. Meanwhile, in another study, Rizky

Luxianto from the University ofIndonesia has compared the effectivenessof momentum and contrarian strategiesin the Indonesian Stock Exchange. Hefirst identifies winner stocks (stocks withhighest gains) and loser stocks (stockswith highest losses) and then buys or sellsthem depending on the whether the strat-egy is contrarian or trend following. Theauthor uses three performance measuresfor selecting winner and loser stocks. The

first method is cross section relativereturn, the second method is cross sec-tion relative return plus risk component(return divided by standard deviation),and the third method is historical relativereturn. According to Luxianto, theresults, for all three methods, prove that amomentum strategy is more effective forwinner stocks, so in the next period win-ner stocks will continue to make profit.For loser stocks, it is more effective to usea contrarian strategy because in the nextperiod loser stocks will rebound andmake a profit after suffering from highlosses.

Kozyra, James and Lento, Camillo, Filter Rules:Follow the Trend, or Take the ContrarianApproach? (August 27, 2010). Luxianto,Rizky, Comparison in Measuring Effectivenessof Momentum and Contrarian Trading Strategyin Indonesian Stock Exchange (August 11,2010).

NEW PAIRSTRADINGSTRATEGYSusana Yu of Montclair State University has developed a newpairs trading rule based on financial analysts buy / hold / sellrecommendations from IBES Details RecommendationDatabase and tested it for the period 1994-2009. She finds thatthe trading rule generally results in positive risk-adjusted returns.It is more effective on small- and mid-cap pairs of stocks thanon large-cap pairs, consistent with the hypothesis of informationdisparity in the stock market. It is more effective in the industriesof mining, finance, and services than in others. In addition, Yuexamined the correlation of analyst recommendations withstock and corporate earnings performance and found significantpositive correlation between recommendations and recent per-formance.

Yu, Susana, Pairs-Trading on Divergent Analyst Recommendations(November 10, 2010). Journal of Investment Management, Forthcoming

All papers are available from the Social ScienceResearch Network, SSRN, www.ssrn.com

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Full course details can be found at: www.technicalanalyst.co.uk/training

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