PO Box 9491
San Diego, CA 92169
(858)-273-5900
An Introduction to Computerized
Technical Analysis
Forty Four Years of Computerized Buy and Sells Signals on The U.S. Stock Markets
by William Schmidt, Ph.D. (Columbia University)
The stock market CAN be predicted much more than most ever imagine. This article will introduce you to concepts used by my Peerless Stock Market Timing Software. These concepts have proven their predictive value over and over. They let us pinpoint the market tops in October 1987, October 1989 and July 1990.
Real-time warnings were then issued to subscribers in our newsletter, PEERLESS FORECASTS, and in our Nightly Hotline. Equally important, the PEERLESS system called the beginnings of major bull markets in August 1982, July 1984, January 1988 and January 1991.
Since its first publication in 1981, thousands of professional traders have read my PEERLESS STOCK MARKET TIMING book and run our Peerless Stock Market Timing Software and our Tiger Software's Power-Stock-Ranker Software. This introduction should give you a basic understanding of many of the key concepts we use to predict stock market’s swings. These are the insights distilled from nearly 30 years of personal trading experience. Each has been verified by computer analysis of as much as 30 years of back data. Their real-time use by hundreds of professional traders has further refined them.
The first thing I want you to do is to greatly reduce the weight you might otherwise attach to the day’s national news - economic, political or financial. We are only interested in the market’s reaction to such news, not the news itself. In that sense we are contrarians. When the market refuses to go down on bad news, it will probably soon make an advance. When it refuses to go up on good news, it will probably next swing downwards.
We are market technicians. We believe the market can best be predicted by
computerized analysis of its own statistics. These statistics include the daily highs,
lows and closes of popular indexes or stocks, as well as their trading volume. We also
break down volume by whether or not the stock rose or fell for the day, and with the New
York Stock Exchange we closely examine statistics derived from the number of shares
trading in advancing stocks and declining stocks. Using our computers we study market
history to find patterns in the data which tend regularly to precede a market advance or
decline. The patterns we test must make intuitive sense. Most often, they stem from the
standard literature of technical analysis.
In the final analysis, we are historians and odds-makers. Absolute certainty is not
possible. Rather, we speak in terms of a particular pattern’s past track record. For
each statistical pattern or PEERLESS automatic signal, we offer data showing the number of
such cases and the resulting gain or loss in, for example, the Dow Jones Industrial
Average (DJIA) or the Standard & Poor’s 100 Index (OEX) over a specified number
of days or at the time of the next reversing automatic PEERLESS signal. This then permits
us to speak in terms of a signal’s average gain and its probability of success.
As technicians, we must first decide the general market’s trend. This has more
influence than anything else on how a stock is apt to perform. Next we must also determine
whether the current stock market is in a stable trading range or if it is strongly
trending up or down. In a trading range, profits are generally made by buying on weakness
at the “support” created by earlier price lows and selling on strength at the
“resistance” created by earlier price highs. However, in a strongly uptrending
market, we do best by buying and letting profits run and by adding to positions when a
stock successfully gets past its earlier price highs. The trick here is to determine the
trend, if any, as soon as possible.
The sooner we see that a market is changing its character, shifting, say, from a
trading range to an uptrending market, the quicker we can profitably shift away from
trading tactics and employ more a buy-and-hold approach. To recognize the general market
trend and to ascertain the strength of the trend the PEERLESS automatic trading system has
developed a number of time-tested major signals which denote a strong uptrend.
The major PEERLESS buy signals consistently get very sizable general market gains at
the time of the next major reversing sell signal. Our PEERLESS system’s 5 major
automatic buy signals show the following track record since 1969 using the Dow Jones
Industrial Average (DJIA).
PEERLESS MAJOR BUY SIGNALS
TRACK RECORD: 1969-1995
No.of Cases Major Buy Signal Average DJI Gain at
Time
of Next Major Sell Signal
------------- ------------------ --------------------------
25--------------- B4 ------------------ 14.8%
113--------------B9 ------------------- 9.6%
14 -------------- B10 ----------------- 14.2%
14 -------------- B12 ----------------- 24.6%
18 -------------- B15 ------------------ 7.1%
I am writing this when the most recent major signal was a BUY "B15".
This occurred on March 27, 1995 with the DJI at 4157. The signal historically averages a
gain of 7.1%. Adding this to 4157, we get an upside target of 4452 - assuming this B15 is
typical. (In actual fact, the DJI moved up to 4872 before a major sell signal warned of a
coming correction.).
The B15 signal occurs because the DJI has shown significant upward momentum. Specifically,
it occurs because the DJI’s 21-day moving average has been rising for 40 straight
days. The 21-day moving average is calculated by taking the sum of the last 21 days of
closing price levels and dividing it by 21. As a new day’s data is added, the data
for the day 21 days earlier is subtracted. We rely heavily on the 21-day period because
that is about the number of trading days in a calendar month and it has been demonstrated
that there is a monthly cycle in the market. Thus, a 21-day moving average is a simple,
but effective, way of smoothing the data to show the true intermediate-term trend.
Click
this icon to see the 1994 PEERLESS chart
of the DJI
The chart above shows the DJI for much of 1995. It also shows the PEERLESS automatic buy
and sell signals, you will see that the rising 21-day moving average has not been violated
for a very long time. In addition, the DJI is showing special momentum. Its uptrend can
neatly be fitted by a parabolic or accelerating uptrend-line. And, the DJI and the other
indices are at all-time highs, where the “path of least resistance” is up. The
market is being driven by human emotions. No one knows where to sell and there lots of
on-lookers who are eagerly waiting for any pull-back to buy. When the parabolic DJI’s
uptrend-line and the 21-day moving average are finally violated, we would typically expect
a severe bout of profit-taking. The market would then probably enter either a downtrend or
a trading range depending on the PEERLESS automatic signals given.
Your personal computer CAN help you predict the stock market much more than you
probably ever imagined. Your computer is a great equalizer when it comes to the stock
market. You can easily do the same type of sophisticated analysis of market statistics and
trading volume that used to be the reserve of big brokerage houses and mutual funds. Now
you can see what the “insiders”` and “big boys” are doing, rather than
what they are saying, and gain a new understanding of how mass emotions and market swings
are regularly predicted by market professionals.
Let's continue our exploration of the most useful tenets of computerized technical
analysis. To begin: when a market is not strongly uptrending or downtrending, the
market tends to move in regular swings up and down. Technicians believe that such a market
is sometimes “overbought” - ripe for profit-taking - and sometimes it is
“oversold” - ripe for bargain hunting. In this they are observing the way
the market moves in cycles of greed and fear. We have found that reliable overbought
conditions may be defined with fixed-interval bands built around a 21-day moving average.
Back in 1981 I introduced this concept to technicians world-wide. It quickly became
popular and is now a standard feature in most technical analysis software packages.
Try this idea. Construct a 21-day moving average of the Dow Jones Industrial
Average’s (DJIA) closing prices. Next have your computer build a band 3.5% above that
moving average and then one 3.5% below it. We have found that for the period 1965-1995,
the DJIA tends to stay within a 3.5% upper and lower band about 90% of the time, usually
bouncing back and forth between the bands.
You will also discover that big market advances many times begin with an initial thrust up
past the normal bands. Much more often, however, the DJIA or a typical individual stock or
market index, stays within the normal bands. Is there a way to tell when the bands will
stop a rally or act successfully reverse a decline? The answer lies in how
accurately we can measure the market’s, or a stock’s, “internal
strength”. Let me now introduce the theory of “internal strength” and
then show you how we measure it. This will often provide a strong clue as to whether the
upper band will successfully block a rally and the subsequent decline will be steep and
disastrous or whether the upper band will be knifed right through and much higher prices
will follow.
Internal strength has many aspects. Here are the most important, in my view. Technicians
often consider a stock to be strong when it rises on high volume and declines on light
volume. In this case, the stock is attracting big, deep-pocketed, new buyers as it
advances while it tends to go down on just light volume, the result of normal
profit-taking. By contrast, a stock which goes up on light volume may not be able to
sustain its advance. It may be rising because the buyers are acting especially
emotionally. Greed has overcome care and caution. At the same time, short-sellers may be
hitting the panic button. Under duress, these players are not very careful in their
placement of orders as they bid up prices. If the rally is heavily due to the covering of
their positions by short-sellers, once the rally ends, the stock or the market may be even
more vulnerable on the next decline.
Low volume rallies are suspect for another reason. Sometimes the rally is less durably
taking place, as on a trading day right before a holiday, when a number of market players
are absent and not actively participating.
In the general market, technicians often want a rally by the Dow Jones Industrial
Average to be confirmed by increasing trading volume and “expanding breadth”.
They consider an advance by the DJIA to new highs to be confirmed if the other popular
averages, like the Standard & Poor’s 500 or the NASDAQ Over-The-Counter Index
make new highs, too. They also want the number of stocks making new highs to be expanding.
And, very importantly, they want the NYSE Advance-Decline Line to be making new highs that
correspond to the DJI’s.
If a rally is mainly in high profile “blue chip” stocks, like those that make
up the Dow Jones Industrial Average, the market breadth is considered “narrow”
and untrustworthy. The NYSE A/D Line is built by computing the difference between the
number of advancing NYSE stocks and declining stocks and then adding that value to the
on-going sum computed from earlier Advances-Declines data. When the DJI makes a new high
which is not followed quickly by the other averages, or the number of new highs, or the
NYSE A/D Line also making a new high, technicians usually consider bearish
“non-confirmations” to have occurred. At the upper band, these signs of weakness
make the market or a stock particularly bearish. Closely related concepts are the basis
for our major “SELL S9” which you can see in the chart of 1990 just below.
Oppositely when only the “blue chip” stocks are falling, the decline is narrow
and false. The appearance of weakness is being maintained, but under the surface the
market strength is building and a good rally is near. If the DJI is reaching its lower
band, where a turn upwards is typical anyway, the market may be ready for an explosive
advance. This is the basis for our major “BUY B9”. (See the 1982-3 chart
attached below.)
Click this icon to see chart of DJI early in
the 1982-1983 Bull Market.
The most important PEERLESS sell signal is our famous “S9”. This occurs when the DJIA reaches an “overbought” position at the daily upper band with our internal strength indicators negative. We build proprietary internal strength indicators from advance/decline, up volume/down volume, total volume and momentum (today’s price divided by the price 25 days ago) data. These internal strength oscillators swing back and forth, from positive to negative, around a base line of 0.
