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Wiser Trader Stocks and Options Newsletter ______________________________________________________________________________
Issue No. 74 April 24, 2006 Prescott, Arizona Systems@WiserTrader.com ______________________________________________________________________________
1.0 Trading
The frequency of day-to-day changes in market direction is one measure of choppiness. By this measure, the market is naturally choppy about 56% of the time.
1.1 Market Character
Directional changes in the William %R are consistent with directional changes in the price of a stock or index. Until recently, I had defined choppiness based on the number of times the NASDAQ Williams %R crossed the neutral line (-50) within a 4-week period. Lately I have been looking at a broader measure of market character based on the average Williams %R for the NASDAQ, DOW, S&P 500, NYSE Composite and Russell 2000. This 5-index Williams %R is derived by adding the Williams %R for all five indices and dividing by five. It is believed that the average of the momentum indicators for all five indices better reflects the market compared to the indicator for a single index. The spread or “range” for the five individual values is also believed to play an important role. When choppiness is defined in terms of the tendency for this 5-index Williams %R to change direction on consecutive days, intuition says that a wider range of values for these five indicators should accompany a more choppy market. While the range is important for the size of a move, it appears to be inversely proportional to the likelihood of a change in direction.
Over the period from January 2004 to April 14, 2006, the 5-index Williams %R changed direction from day-to-day about 55.8% of the time. The market, defined in this case by the five indices, moved in the same direction for two or more days in a row only 44.5% of the time. The range of the 5 index values on any given day varied over that same period from 1 to 81 with an arithmetic average value of 25. Table 1 shows the percentage of day-to-day changes in direction of the 5-index Williams %R along with the previous day’s range. The highest percentage of day-to-day changes in direction was 17% when the previous day’s range was between 10 and 15 units. Half the changes in direction occurred on either side of a range of 20 units.
Therefore, a wider range for the five values of the Williams %R on any given day does not correlate well with a tendency for day-to-day reversals. Rather, it seems, when all five indicators have similar momentum, a reversal on the following day becomes more likely. This is counter intuitive and is likely to be different for larger, more prolonged changes. A histogram of the range on the day before a reversal is given in Figure1.
Table 1 Percentage of 5-Index Williams %R Changes in Direction Based on the Previous Day’s Range
FIGURE 1
Table 2 provides a summary of the number of consecutive days the 5-index Williams %R moved in the same direction over the January 2004 to April 14, 2006 period. The 5-index momentum indicator varied from -1 to -99 with an arithmetic average of -43. We can see from the table that the market moved in the same direction for 2 or more consecutive days about 44.5% of the time.
Table 2
Table 2 only provides average values for the 5-index indicator and range. Another picture can be gleaned from the chart in Figure 2 showing a more detailed relationship between the 5-index indicator and range on the day before a change in direction. Figure 2 illustrates how reversals are more likely when the range is small and the 5-index indicator is near an extreme above -20 or below -80. This greater likelihood of a reversal at the overbought and oversold extremes should be expected. The slightly greater tendency for a reversal when the indicator is overbought can be explained by noting that the market historically spends more time in that area, having a long term upward bias. Between -20 and -80, the likelihood of a reversal is less predictable.
FIGURE 2
Figure 2 has an interesting symmetry that will be discussed in the future. Keep in mind here that the discussion is about describing historical day-to-day changes in direction. We have not addressed prediction or the size of moves. Those are future studies. The first step towards a good model is a good description. Markets are characterized as trending, choppy or moving sideways depending on the period over which they are observed and the technical indicators being used.
If you have an interest in tracking the 5-index Williams %R and range, the charts in Figures 3 and 4 are one way to go. These 3-month charts are updated automatically and continuously in an Excel spreadsheet running XLQ-Plus. This spreadsheet, named Market Momentum, is available for download at http://www.wisertrader.com/excel.php .
FIGURE 3
FIGURE 4
2.0 Market Analysis
This week the market rose despite a rise in the CPI to about 0.7% above this time a year ago and a rise in the price of oil above $75 a barrel. About one third of S&P 500 companies have reported with 70% being above expectations. FOMC minutes gave encouraging news that the committee is mindful of over tightening. Ten-year bond yields remained steady at about 5%.
Key industry ETF’s in Table 2A are Biotech and Semiconductors, which confirm the NASDAQ. Transportation confirms the Dow Jones Industrial Average according to Dow Theory. Banking and Financials are confirming indicators for the S&P 500. Gold and Housing are respective indicators for the inverse health of the currency (inflation) and the capacity for consumer spending.
Table 2A Indices, Key Industry ETF’s and Sector SPDR’s
The VIX and VXN volatility indexes are listed in Table 2B.
Table 2B Volatility
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Table 2C
Market Summary
Industries are listed according to the Dow Jones Classification System