Trader’s Narrative

Continuing with the series, here is the fourth condition of a new bull market as outlined by Jim Stack of InvesTech:

I’ve hesitated to mention this technical indicator since I started writing this blog because it is almost too good. It is one of the few that have an uncanny ability to find the start of almost all major bull markets. So you can understand why I don’t want to run the risk of ruining it by popularizing it any more than it is. And it is not popular at all.

In fact, compared to say the RSI or MACD, the Coppock Guide is an esoteric and rarely mentioned technical indicator. It was created by Edwin S. Coppock some 50 years ago and although it is followed closely by a very small group of technical analysts, its calculation is not complicated at all.

You can keep track of it yourself. Here’s the recipe: you need historical monthly Dow Jones Industrial data. You add the 14 month ROC to an 11 month ROC, then you take a 10 month (simple linear) weighted moving average of the result. That’s it.

If you’re mathematically astute, you’ve already noticed that it is just another oscillator. Here is the chart of the Coppock Guide for the past few years, courtesy of InvesTech:

How is the Coppock Guide interpreted?
The most traditional interpretation is to recognize a buy signal when the Coppock Guide curls up while it is below the zero line.

It can also provide sell signals, although these are less frequent. If the Coppock curve makes a double top formation without first having come down to the zero line (or below it), the market is in for a seriously brutal bear market. You should be able to find one such occurrence in the chart.

So you can see why I think it is almost too good to share. In its history, only 4 false signals have occurred. That’s an 83% accuracy rate.

What is the Coppock Guide saying now?
The good news is that the Coppock Guide is in negative territory projected to fall into negative territory this month. So now any upturn can potentially give us a buy signal. The bad news is that this may happen next week, next month or next year.

The key factor is an upturn. But that can happen from an incredibly low level, like say in 1974 or 1932 (not shown) or it may happen just under the zero line, as in 1994.

Although no indicator can give a full iron clad guarantee, when the Coppock Guide turns up it would totally skew the probabilities towards a new bull market. As always I’m keeping a close watch and now that “the cat is out of the bag”, you can too.

Moving averages are one of, if not, the first indicator that people are introduced to. They are simple to calculate, simple to understand and they seemingly smooth out the price on a chart, painting beautifully rounded hills and valleys. Most plot them right on the price chart and use them to show areas of support or resistance. See!, they say, price hit the 200 day moving average, that’s resistance!

Being a rebel, I use moving averages differently. First, I try to not plot them on top of my price charts since I prefer to keep the chart clean of any distractions. Price is the main feature and everything else keys off it. So why create distractions from the most important element?

Second, I refer to moving averages to find areas of extreme expansion. Think of price as an elastic band that can stretch above and below the moving average. As it does, it reaches a point where it just can’t stretch any further and starts to snap back. Mean reversion for the more mathematically inclined.

So what I do is modify the MACD to show this elastic character of prices. Moving Average Convergence Divergence (MACD) is probably the next most common indicator after moving averages. And yet most people have neither any understanding of how it is calculated nor how they should use it. To have the MACD indicator plot the movement of price away from a moving average change the default setting to: 1, X, 1 — where X stands for the period of the moving average you want.

Let me show you how I use this. I mentioned that I liked North West Company Fund (NWF.un) in June 2006 (note that in Sept 2006 there was a 3:1 split). Last year, the Canadian income trust market reacted with panic selling on Halloween as the Harper government reneged on their promise to not tax income trusts. Without any shame, they lied to the Canadian people. But what politician hasn’t?

North West wasn’t spared as it gapped down hard on very high volume. There was panic in the sector as the ground has suddenly shifted. Sentiment was very negative with many claiming this was the death knell for income trusts in general. I bought at $13.55 (all prices in Cdn dollars). That would be the green dot on the chart.

There was a momentary recovery and a second spike down. Such a move leads to a double bottom or a further decline - either way, a clear technical would tell me and I would limit any potential losses. It’s important to remember that North West’s business was humming along with great earnings. And I knew that I would be paid a distribution as I waited for cooler heads to prevail.

See the chart above the price chart for North West? That is the relative behavior of price to the 50 day simple moving average. By the way, there is nothing magical about the 50 moving average, it wouldn’t make a difference if you used the 33, 40, 43, etc. moving averages. Consistency is important though since we don’t want to compare apples to oranges.

Notice how the previous swing high in September 2006 was stopped as price was stretched to the upside (red rounded box). The November spike down was the mirror opposite of that situation. Of course, price simply can not bounce from one extreme (oversold) to the next extreme (overbought) within a short time. Especially when we’re dealing with a low beta security like an income trust. So I sat. And my sitting, as Jesse Livermore would say, made money. I got out a few days ago at $20.28 .

Here are the fills I got from Interactive Brokers:

NWF.UN 2006-11-13, 14:07:22 TSE 13.5500
NWF.UN 2007-04-30, 11:14:14 TSE 20.2800