January - February 2009 Newsletter

Main Article

Combining Relative Strength and Other Technical Indicators

Contributed by Michael Carr

Technical analysts have spent decades creating formulas designed to give them a trading edge. Many are based upon the principle that changes in momentum will occur before changes in price trend, in other words technicians are saying that Relative Strength (RS) in a stock’s past performance is a good indicator of future price appreciation. Examples of technical indicators include stochastics, the moving average convergence-divergence indicator (MACD), and the Relative Strength Index (RSI).

RSI was introduced to the world by Welles Wilder in 1978. It is among the most popular momentum oscillators used by technicians, and is a very useful component in many trading strategies. The RSI compares the strength of a stock's recent upside movement to the magnitude of its recent losses and provides that information as a single value that ranges from 0 to 100. However, it is not a measure of comparative RS because it does not take into account the performance of other stocks or the market itself. The theory behind the RSI is that it will identify those times when a stock has moved too far, too fast and is due to exhibit mean reverting behavior causing a reversal of the current trend. It is intended to spot tops and bottoms rather than find stocks that are starting to move higher for an extended period of time, as RS seeks to do.

MACD measures the difference between a short-term and long-term moving average of closing prices. The longer moving average is subtracted from the shorter moving average. The theory behind this indicator is that this calculation of a stock’s momentum will show when prices are changing directions. A positive value of MACD indicates that the short-term MA is trading above the long-term MA. A negative MACD indicates the opposite. If MACD is positive and rising, then the gap between the two MAs is widening, which means the rate of change of the short-term MA is higher than the rate of change for the long-term MA. This should lead to higher prices for the stock. If MACD is negative and declining further, then downward momentum is accelerating, and lower prices are to be expected.

The MACD indicator has been adapted as a measure of RS by Christopher Hendrix, CMT.ii Hendrix substitutes a RS calculation for price into the traditional MACD formula and creates a Momentum of Comparative Strength (MoCS) formula:

MoCS = (12-period EMA of (Stock/S&P 500)) – (26-period EMA (Stock/S&P 500))

where EMA represents an exponential moving average

Stock represents the closing price of the stock being evaluated

S&P 500 represents the close of the S&P 500 Index

An exponential moving average (EMA) is used by some market technicians to reduce the time lag introduced with simple moving averages. When using a moving average to smooth the data and help identify the trend, some delay is introduced into the price series. EMA's reduce the lag by overweighting the importance of more recent prices, with the amount of overweighting determined by the specified period of the EMA. Shorter period EMAs overweight the most recent price more than longer period EMAs. In the MoCS formula, the most recent close accounts for 15 percent of the value of the 12-period EMA, and the 26-period EMA derives about 7.5 percent of its value from the most current price. Because it puts more weight on recent prices, an EMA will react quicker to recent price changes than a simple moving average which equally weights all data points.

Trading signals are generated when a 9-period EMA of the MoCS crosses above or below the current value of the MoCS. An example is shown in Figure 1. Buys are signified when the solid line is above the dotted line, sell signals are the reverse. The advantage of MoCS is that it compares the movement of a stock to the overall market but allows the investor to apply a RS strategy to a single security, rather than requiring that an investment universe be rank ordered and sorted into percentiles. The chart shows there are clear buy and sell signals based only upon the behavior of this stock compared to the market.

Figure 1: Modifying the formula of the well-known MACD technical indicator to measure RS allows an investor to see clear buy and sell signals for an individual security. The Momentum of Comparative Strength (MoCS) indicator is shown in the bottom panel of this figure. In this case, a buy signal occurs when the solid line crosses above the dashed line, and a sell occurs when the solid line falls below the dashed line.

As can be seen in Figure 1, MoCS offers timely signals. Its sell signals are usually closer to the top than the signals given by other indicators. Traditional oscillators give a large number of false signals. Using weekly settings for MoCS provides very few signals, and even fewer losing trades.

This technique can be applied to any technical indicator by adapting the formula to use a RS ratio instead of the stock’s closing price. It is a highly adaptable strategy which can employ RSI, or stochastics, for example, instead of using MACD. Alternatively, investors can change the time periods for MACD to generate a greater or lesser number of signals.

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Support Tip

How can I backup my formulas? (Indicators, Experts, Explorations & System Tests)

Contributed by Equis Support

All of your formulas can be quickly backed up by the following procedure:

1. Open MetaStock
2. Click Tools | Indicator Builder
3. Click Organizer
4. Click Export
5. For each of the formula based tools, select the items to be backed up.
6. Specify the location you wish to export the files to. You can password protect them here, but we advise you not to unless you are distributing them to other people you do not want to have access to the formula code.
7. Click OK

This will back up the selected formula files in the destination location you specify. Although safe guards are put into place to in MetaStock to mitigate loss of data, backing up your work provides you with additional peace of mind; therefore we recommend that you regularly back up your work.

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MetaStock Features

MetaStock Scanning

Contributed by David Derricott

One of the most commonly used features in MetaStock is the ability to scan. This is a very powerful and useful part of the program. It’s a great way to find securities you want to trade, will help you decide when to trade, and if you should stay out of the market. A very simple and easy scan you can create using MetaStock is scanning for buy and sell signals when a moving average crosses above or below the price bar over the last 20 days.

Another great part of the scanner is the ability to make the scans as simple or as complex as you would like. MetaStock has about 40-50 pre-programmed scans included in the software. You can use historical data to back test these scans to see how they perform over any given period of time. Once you have determined which scans work best for you, you can apply these to your trading portfolio. MetaStock provides data for 30 years on daily charts and one year on intraday charts. The scanning capabilities within MetaStock work well for both end of day traders and real time traders. It doesn’t matter if you trade stocks, options, futures, or forex the program will work great with all markets.

If you would like assistance with setting these scans you can contact our support team. We offer world class support and all our representatives are very knowledgeable and will spend as much time as needed to assist you with your questions and problems. In the past year MetaStock support representatives have answered 85% of their calls in two minutes or less. You can contact the support department via phone, email, or online using our support chat feature.

For more information regarding the scanning feature found within MetaStock, please contact David Derricott directly at 800.587.8012 or via email at david.derricott@thomsonreuters.com.

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