55 - 2001 Summer PDF

SM
MTA JOURNAL
Spring-Summer 2001
Issue 55
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THE MTA JOURNAL TABLE OF CONTENTS

SPRING-SUMMER 2001
ISSUE 55
MTA JOURNAL EDITORIAL STAFF
ABOUT THE MTA JOURNAL
2000-2001 MTA BOARD OF DIRECTORS AND MANAGEMENT COMMITTEE
EDITOR'S COMMENTARY
Henry O. (Hank) Pruden, Ph.D., Editor
NEW APPLICATIONS FOR OPEN INTEREST IN U.S. TREASURY BOND FUTURES:

A MONEY FLOW VS. BREADTH APPROACH
Sal Greco, CFA, CMT
APPLYING VODOPICH'S INTEGRATION OF ELLIOTT AND GANN TO THE

LONG-TERM STUDY OF THE DOW JONES I NDUSTRIAL AVERAGE
35
William K.N. Chan, CFA
INTERMARKET BREADTH I NDICATORS: DOES THE PRICE ACTION OF I NTEREST RATE

SENSITIVE STOCKS PROVIDE CLUES TO TRENDS IN BONDS PRICES?
41
Gary Stone, CMT
WYCKOFF TESTS: NINE CLASSIC TESTS FOR ACCUMULATION; NINE NEW TESTS FOR RE-ACCUMULATION
29
Jordan E. Kotick, B.A (Hons), M.A., CMT
A CRITICAL STUDY ON THE EFFICACY OF STOP-LOSS
21
Blethyn Hulton
THE METAPHYSICAL IMPLICATIONS OF THE E LLIOTT WAVE PRINCIPLE
51
Henry O. (Hank) Pruden, Ph.D.
MTA JOURNAL
Spring-Summer 2001
THE MTA JOURNAL

SPRING - SUMMER 2001
ISSUE 55
EDITOR
Henry O. Pruden, Ph.D.
Golden Gate University
San Francisco, California
ASSOCIATE EDITOR
David L. Upshaw, CFA, CMT
Lake Quivira, Kansas
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MTA JOURNAL
Spring-Summer 2001
ABOUT THE MTA JOURNAL

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2000-2001 BOARD OF DIRECTORS AND MANAGEMENT COMMITTEE

OF THE MARKET TECHNICIANS ASSOCIATION, INC.
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EDITOR'S COMMENTARY
MULTI-METHOD RESEARCH
As technical analysts strive to raise their body of knowledge and discipline to higher
standards, the canons of the scientific method and empirical testing will become more
and more commonplace. In earlier Editorials, the case was made for the formulation
and testing of Theoretical Models. In this issue there are examples of the two polar
approaches to doing empirical research in the social sciences, hence in behavioral finance and technical analysis. These two poles can be characterized as survey research
findings across a large number of instances to establish statistical validity and reliability
on the one extreme, and the individual case study on the other pole. The individual
case study illustrates numerous variables and contingencies operating together in a
real-life situation.
Most of our MTA Journal articles rely upon the survey type of technique, which is
appropriate and excellent. But there remains an art form to the execution of trades
and a complexity of interacting indicators and decisions that are better revealed through
the story of a case study. In this issue of the MTA Journal the article on Wyckoff
Rules is an exposition based upon a case study. Other technical analysts are encouraged to consider using the single-case approach to document their studies, perhaps
relating case studies based upon their own experiences.
MTA JOURNAL
Spring-Summer 2001
EDITOR'S COMMENTARY
APPROACHES TO THE BODY OF KNOWLEDGE IN

TECHNICAL MARKET ANALYSIS
ANOTHER PERSPECTIVE
I have a great respect for orthodoxy; not for those orthodoxies which prevail in particular
schools or nations, and which vary from age to age, but for a certain shrewd orthodoxy which the
sentiment and practice of laymen maintain everywhere. I think that common sense, in a rough
dogged way, is technically sounder than the special schools of philosophy, each of which squints
and overlooks half the facts and half the difficulties in its eagerness to find in some detail the key
to the whole. I am animated by distrust of all high guesses, and by sympathy with the old prejudices and workaday opinions of mankind: they are ill expressed, but they are well grounded.
My philosophy is justified, and has been justified in all ages and countries by the facts before
every man's eyes; and no great wit is requisite to discover it, only (what is rarer than wit) candor
and courage. Learning does not liberate men from superstition when their souls are cowed or
perplexed; and, without special learning, clear eyes and honest reflection can discern the hang
of the world, and distinguish the edge of truth from the might of imagination.
George Santayana, Preface to a New Philosophy
MTA JOURNAL
Spring-Summer 2001
NEW APPLICATIONS FOR OPEN INTEREST IN U.S. TREASURY

BOND FUTURES: A MONEY FLOW VS. BREADTH APPROACH
Sal Greco, CFA, CMT
INTRODUCTION
panying specific price action. These principles represent the basic

tenets of a Breadth framework, and are summarized in figures 1
through 3.
The conventional wisdom of technical analysis maintains that Volume (Vol) and Open Interest (OI) studies are breadth indicators.
Each measures the continued health, or potential weakening, of a
given trend. We expect increases in Vol and OI as prices move in the
direction of the primary trend, while we tolerate decreases in each as
prices move contrary to that trend. This application of Vol and OI
data is clear in the technical analysis literature.
My work suggests that more valuable and timely applications of
OI exist in the exchange-traded futures markets, specifically the US
Treasury Bond Futures market. In addition to providing broad confirmation of trend, or signaling pending divergence to the trend, OI
figures provide vital insight into sentiment levels within particular
markets. As such, OI provides information which is often contrary in
nature and more appropriately utilized as a shorter-term sentiment
gauge rather than as a longer-term breadth indicator. This paper
will show how OI data analysis can be extended into the area of market sentiment and contrary opinion, through a greater dissection of
the Commodity Futures Trading Commissions Commitment of Traders Reports. It will demonstrate ways to decompose changes in OI
that better reflect the true nature of positions in the UST Bond Futures market, and offer methodologies that can be used to forecast
price action on a shorter-term basis.
Figure 2 Interpretation of Price/Vol/OI Interplay

Prices
Volume
Open
Interest
Market
Interpretations
RISING
Increasing
Increasing
STRONG
Decreasing
Decreasing
WEAK
Increasing
Increasing
STRONG
Decreasing
Decreasing
WEAK
FALLING
The inherent delay between Breadth divergence and price reversals makes it difficult to translate breadth analyses into short-run trading strategies. Some of the more recent work on OI has attempted to
improve upon the Breadth framework in this regard. Hadady (1989)
developed the Price Open Interest (POI) Indicator to address this
issue. Hadady characterized percentage changes in Price and OI along
a Bullish-to-Bearish continuum. He reasoned that during those periods in which OI diverged from price action, bullish and bearish signals could be derived from the relative percentage changes of Price
and OI. Though intellectually appealing, application and interpretation are difficult for a number of reasons.
Figure 3 Interpretation of Price /OI Principles
TWO FRAMEWORKS FOR OI ANALYSIS
Common Major Interpretation
OI analysis can be conducted under two distinct, but complementary, frameworks: a Breadth framework and a Money Flow framework. Each framework interprets changes in Total OI as an indication of whether money is flowing into or out of a given market. Rising OI represents money flowing into a market, while falling OI represents money flowing out. From this point of common interpretation, the two frameworks quickly diverge.
Figure 1 Formation of OI
Sale
New Long
New Short
Increases
New Long
Old Long
Unchanged
Old Short
New Short
Unchanged
Old Short
Old Long
Decreases
Rising OI in an Uptrend is Bullish
New Longs and New Shorts Entering
Decling OI in an Uptrend is Bearish
Short-Covering and/or Long Selling
III.
Rising OI in a Downtrend is Bearsh
New Longs and New Shorts Entering
IV.
Declining OI in a Downtrend is Bullish
Short-Covering and Longs Selling
A Money Flow Framework

A Money Flow framework distinguishes between the sources of
the money entering the market, and the sources of the money leaving the market. It does not assume that all money is created equal
at least over the short-run. In fact, a Money Flow framework reasons
that bad money will eventually follow good money into a market. This
can have dire consequences to a market over the short-term, regardless of whether the longer term is showing broad participation. Hence,
all new money entering a market is not unequivocally good. In its
most basic form, a Money Flow framework seeks to identify the strong
versus weak hands of the market and to determine which faction is
driving price action at any given time.
OI Effect
There are several basic principles of OI analysis with which all

technicians are familiar. These include how OI is affected by buying
and selling in the zero-sum environment of the futures market, as
well as the generalized interpretations of changes to Total OI accom-
MTA JOURNAL
I.
II.
Painter (1995) addressed the same issue with his On-Balance Open
Interest Indicator (OBOII), a variant of Joseph Granvilles On-Balance Volume (OBV). Painter used the major tenets and principles of
OI to create a time series which provided signals of confirmation and
divergence on a cumulative basis. His methodology incorporated
the use of dummy variables (not derived from actual market data)
which were generated by four different market states. He used these
variables to construct a cumulative index that identified changes to
the intermediate trend. Though it provides an ongoing, cumulative
measure of breadth, the inherent weaknesses of a breadth framework
remain.
A Breadth Framework
A Breadth framework does not differentiate between the activity
of different participants. All new money (rising OI) supports the
primary trend, regardless of who is establishing new positions and on
which side of the market they are doing so. So long as new positions
are established, there is fuel available to feed the trend. This underscores the longer term nature of a Breadth framework, where the
goal is to identify signals of confirmation of or divergence from to
the longer-term trend.
Purchase
Underlying Reasoning
Spring-Summer 2001
Rather than characterizing changes to Total OI, a Money Flow

framework identifies changes in the composition of Total OI. The
positioning of similarly categorized participants, over time, in a zerosum futures market, often yields the presence of strong-handed and/
or weak-handed players whose net positions cycle with price action.
If such a situation exists, principles of contrary opinion can be used
to generate more effective Buy and Sell signals than could be generated from a Breadth framework. A Money Flow framework provides
superior Buy and Sell signals because of its shorter time frame, and
its differentiation of market positions.
For purposes of OI analysis, the separation of strong-handed players from weak-handed players is accomplished through decomposition of the Commodity Futures Trading Commissions (CFTC) Commitment of Traders (CoT) Reports. Since an understanding of the
CoT Report and reporting process is critical to understanding the
Money Flow framework, the CoT Report is discussed more fully in
Appendix A.
Conventional wisdom suggests that, as a general rule, the Large
Trader category of the CoT Report represents the strong-handed,
smart money compared with the Small Traders weak-handed
dumb money. Belveal (1985) offered just such a methodology for
broad application of the CoT data. He split gross long and short OI
positions into percentages based on whether the positions were held
by Large (Commercial and Non-Commercial) or Small Traders (NonReporting). Belveals analyses focused on how changes in OI shifted
this allocation, and compared the relative positions of Large and Small
Traders over time.
Jiler (1985) analyzed the forecasting ability of the major identifiable groups of market participants: Large Hedgers (LH), Large
Speculators (LS), and Small Traders (ST). He used Net open contract positions as a percentage of OI to determine the relative positions of participants. Further, in an attempt to remove any seasonality present in the underlying commodity market, Jiler derived normalized or average positions to which he would compare actual positions taken from the CoT reports. He viewed material deviations
from the norm as a measure of bullish or bearish attitudes on the
market. Jiler found that LH and LS had the best track record for
forecasting price action across markets, with the LH consistently superior to LS. However, LS performance varied widely from market
to market. ST had the worst record by far, across virtually all markets. Jiler concluded, therefore, that bullish signals on the market
should be taken when, on a percentage basis, LH are net long more
than normal, LS are net long, and ST are heavily net short by more
than their normalized amount.
be an incomplete and/or inaccurate decomposition of positioning

in the market. This is true for bonds. The CoT Report combines the
activity of participants whose Net Positions (and hence market views)
are inversely related, while separating the activity of players who are
like-minded. Therefore, neither a Comml versus Spec nor a LT versus
ST segregation will accurately reflect the true level of market sentiment contained in the CoT Report.
Exhibit 1
Exhibit 2
A MONEY FLOW FRAMEWORK FOR

TREASURY FUTURES
Decomposition of the Treasury Bond Future CoT Report
This conventional wisdom, as represented by Belveal and Jiler,
provides an incomplete decomposition of the CoT Report for bonds.
Exhibits 1 and 2 separates the bond CoT Report into the traditional
categories of analysis: Large Traders (LT), Small Traders (ST), Commercials (Comml), and Speculators (Specs). Exhibit 1 shows that LT
and ST positions are perfect offsets. This is a basic identity property
of the CoT Report. Since Total Net Positions must sum to zero, and
all positions are classified as either LT or ST, these two components
will always, by definition, offset each other. Comml and Specs, whose
positions are clearly inversely related, are not perfect offsets, since
each are included in the LT component of the CoT Report. Therefore, unless the LT/ST division completely reflects behavior, it may
MTA JOURNAL
Spring-Summer 2001
10
Figure 4 : US Treasury Bond OI (Jan86-Nov98)
The utility of the CoT Report is derived from two measures: Total
Absolute Net Positions and the positioning of Comml versus Specs and STs.
[I refer to the combined positions of Specs and ST as FADE positions.] Any decomposition must capture and measure both to be
effective. Total Absolute Net Positions (TAbs Net Pos) gauge the
magnitude of conflicting opinion in the market by measuring how
far from Neutral the net positions of adversarial participants have
moved, while the relative positioning of Comml vs. Specs/ST depicts
the polarity (long v. short) of the smart money.
Although there is no identity property that states the Spec and ST
categories must align, they do so more often than not, especially as
TAbs Net Pos increase. For example, the Spec and ST components
are aligned similarly in 304, or 63%, of the 482 weekly observations
in the CoT Report for bonds between January 1986 and November
1998. The observations that do not align occur in periods of relatively low TAbs Net Positions. Specifically, of the 178 (37%) observations in which the Net Pos of Specs and NRPT are not aligned, 153,
or 86%, occur when TAb Net Positions are less than 15% of Spread
Adjusted OI. As can be seen in Exhibit 3, this is a relatively low reading for TAbs Net Pos in the CoT Report for bonds. Simply put, when
the magnitude of disagreement is small, the relative positioning of
the players matters less.
With this in mind, a more appropriate CoT decomposition for
bonds is provided in Exhibit 4. The first graph shows TAbs Net Pos
between January 1986 and November 1998. The second and third
graphs show Net Comml Pos and Net FADE Pos, respectively. Although the sum of the absolute values of the second and third graph
will not always equal the first, the latter two graphs are now perfect
offsets. This confirms that the strong- and weak-handed components
are correctly accounted for, even if they fail to perfectly align on opposite sides of the market in every observation.
In order to remove the trends caused by dramatic increases in OI
over the last few years (Figure 4), each category is restated as a percentage of Spread Adjusted OI (defined in Appendix A) in Exhibit 5.
This adds a degree of relativity to the time series for purposes of historical comparison. These OI-adjusted time series are defined in Figure 5. Further, Exhibit 5 clarifies the relationship between TAbs Net
Pos and CoT%C & CoT%FADE. As TAbs Net Pos increase, conflicting opinions/positions in the market are on the rise. As OI is buoyed
by this increase in TAbs Net Positions, the market position of the
strong versus weak hand of the market becomes more polar or extreme. As the exhibit shows, CoT%C and CoT%FADE can move to
either extreme as TAbs Pos are forced higher.
Figure 5 : Definition of CoT Derivations

CoT%LT:
Net Pos of LT as % of Spread Adj OI
CoT%ST:
Net Pos of NRPT as % of Spread Adj OI
CoT%C:
Net Pos of Comml as % of Spread Adj OI
CoT%S:
Net Pos of Spec as % of Spread Adj OI
CoT%Fade:
Net Pos of (Spec + ST) as % of Spread Adj OI
Exhibit 4
Exhibit 3
Both CoT%C and CoT%FADE are the algebraic equivalent of a

diffusion index. A diffusion index measures the difference between
3 or more variables that have cyclical properties, making it the most
appropriate measure to determine the relative positioning between
the strong and weak hands in the bond market. Although CoT%C is
defined as Net Commercial Positions as a percentage of Spread Adjusted OI, the identity properties of OI assure that CoT%C is pro-
MTA JOURNAL
Spring-Summer 2001
11
Exhibit 6
portionally equivalent to the difference between the Net Positions of

Commercials and the Net Positions of the FADE Category (CoT%C
(CoT%S + CoT%ST). Specifically, the CoT%C is equivalent to twice
the magnitude of a pure Diffusion Index which utilizes CoT%C,
CoT%S, and CoT%NR.
(CoT%C - CoT%S - CoT%NR)
CoT Diffusion Index (DI) = --------------------------------------------------- = 2* CoT%C
Spread Adjusted OI
[Appendix B provides an algebraic derivation of the Diffusion

Index (DI)]
Exhibit 5
Market and Trading Applications

These methodologies can be applied over relatively short time
frames for the purposes of market-timing in the bond market. Application addresses three issues.
First, the short-term assessment of market opportunity or risk is
driven largely by TAbs Net Pos. TAbs Net Pos represent the primary
gauge of market conflict. When TAbs Net Pos reaches a relatively
high level, a reversal of price action on a reduction in OI can be
expected. During these periods, execution of positions in the direction of the
trend (purchases in uptrends; sales in downtrends) should be delayed while
execution of positions or transactions against the trend (purchases in
downtrends; sales in uptrends) should be accelerated. Likewise, when TAbs
Net Pos reverses from relatively high levels to more moderate or below average levels, the degree of conflict that drove prices to recent
highs or lows has likely moderated. Generally, this represents a reduction in the speculative forces that were driving price action. As
these forces subside, the trend and the breadth of participation in
the prevailing trend can be reassessed.
Second, CoT%C or the CoT DI is used to determine which way
the market is likely to break, once the speculative forces have exhausted themselves. As stated earlier, when the TAbs Net Pos is high,
positioning of the players becomes more meaningful. Thus CoT%C
and CoT DI will show whether the strong-handed players are on the
long or short side of the market at these times of maximum position
conflict. If the strong hands are long (CoT%C relatively high), long positions can be taken, or purchases accelerated/sales slowed, in anticipation of a
rally that ensues as the speculative forces that pushed prices lower are exhausted. Conversely, if the strong hands are short (CoT%C relatively low),
short positions can be taken, or sales accelerated/purchases slowed, in anticipation of a sell-off that occurs as the speculative forces that had pushed prices
higher are exhausted. [Box A provides 3 examples of application.]
The definition and interpretation of the DI is relatively simple.

Since the sum of the three terms must equal zero, and the sum of two
must be equal and opposite to the third, the DI must vary between 2
and -2. These extreme readings represent the largest potential difference in Net Positions between Comml and FADE categories. The
value is positive when the Commls are on the long side, and negative
when Commls are on the short side. Since CoT%C is equal to onehalf of the DI value, it will vary proportionally between +1 and -1 with
a similar interpretation. Exhibit 6 shows both CoT%C and CoT DI.
Regardless of which measure is used, this formulation represents the
broadest derivation of the relative positioning between the strong and
weak hands in the Treasury Futures market provided by the CoT Report.
MTA JOURNAL
Spring-Summer 2001
12
Exhibits 7
Exhibits 7A
Box A
See Exhibits 7 and 7A. In Jan 98, bonds traded as high as 123.17 on a closing basis. Spread Adj OI
increased by approximately 32% between early Sep and mid-Jan as bonds were making their highs. TAbs
Net Pos rose from a neutral 1.0% to 31.6% at the high. Coincident to the increase in TAbs Net Pos,
CoT%C moved from .3% to -15.8%, a bearish extreme. This was a clear signal that bonds were spurred
higher on an increase in speculative activity. The increasing conflict between the strong and weak factions
of the market was underscored by a dramatic increase in TAbs Net Pos, and CoT%C maintained the
unwinding of conflicting opinion would lead to lower prices. By the time this conflict was unwound in
early Mar, and these indicators moved back to Neutral levels, bonds had fallen 4-3/4 points.
A similar scenario developed in Jan 96 as bonds traded to the year low yield of 5.92%. Bonds rallied 8
5/8 points between the end of Sep and early Jan 96 on a 28% increase in OI. As OI increased over that
period, TAbs Net Positions rose from 6.4% to 21.2%, suggesting increasing conflict and polarity in market
sentiment and positions. CoT%Cs move from 3.1% to -8.2% suggested this would be resolved through
lower Bond prices. Over the ensuing 4 months, Bond prices fell over 14 points as these indicators moved
to Neutral levels.
Price action in May 95 illustrates how similar increases in TAbs Net Positions led to dramatic rallies.
Bonds were fighting psychological resistance at 5.25% in May 95 following the 1994 Bear Market in bonds.
After rallying over 3-1/2 points from the beginning of the year to early Feb, bonds rallied an additional 31/8 points by early May 95. OI increased by 7.5% over the first part of the rally, and fell by approximately
2.5% over the latter part. As bonds rallied nearly 6-3/4 points between Jan and May95, TAbs Net Positions
increased from 13.9% to 26%. CoT%C increased from 6.9% in early Jan to 13.0% in early May following
only a slight moderation in early Feb. In this instance, CoT%C suggested the increased conflict in positioning would be resolved via higher prices since the strong hand of the market had continued to accumulate positions. The rally that ensued saw bonds rally by more than 9-1/2 points in little over four weeks.
MTA JOURNAL
Spring-Summer 2001
13
Exhibit 8
Exhibit 8A
BOX B
Jul 97 and Oct 98 are two times in which TAbs Net Positions did not mirror the
change in Spread Adjusted OI. [See Exhibit 8 and 8A]. In Jul 97 bonds were completing a rally begun in mid-Apr97. Spread Adj OI increased by 21% as bond prices climbed
nearly 8-1/2 points. Coincident to the increase in OI, TAbs Net Pos increased from
9.0% to 30.6% at the highs. As bond prices fell by 2-3/4 points in Aug, OI increased by
4%. However, as OI rose, TAbs Net Pos moved from 30.6% to 1.0%, in a dramatic
moderation in sentiment. As such, the market was unencumbered by speculative excess as prices began to climb in early September. This set the stage for further gains.
By the time TAbs Net Pos revisited the 30.8% area in mid-Dec, bonds were seven points
higher.
Oct98 represents a recent example of OI and TAbs Net Positions moving in opposite directions. In this instance, a dramatic decrease in Spread Adjusted OI was accompanied by an increase in TAbs Net Pos. During the liquidity crisis of Jul 98-Oct 98
bonds rallied smartly as a flight to quality put a bid under the Treasury market. Bond
prices rallied 10 points between the end of Jul and early Oct. Spread Adjusted OI,
which had already peaked in mid-Jun, fell an additional 15% between the end of Jul
and the high prices of early Oct. Over the same period, TAbs Net Pos rose to 36.4%
from 20.8%. Therefore, as money was leaving the market (OI falling), prices were
being driven higher by speculative forces (i.e. TAbs Net Pos rising; CoT%C falling).
The divergence between prices (up 10 pts) and OI (down 25%) quickly became acute
when TAbs Net Positions reached the 36.4% level. Prices reversed quickly thereafter.
MTA JOURNAL
Spring-Summer 2001
14
BIBLIOGRAPHY
Third, the relationship between TAbs Net Pos and Total OI outstanding can be used to determine whether significant corrections to
the trend are necessary and should be anticipated. TAbs Net Pos
typically increases as Total OI increases. This dynamic provides the
early signs that bad money is beginning to follow good money into
the market over the short-to-intermediate time frame. However, this
need not be the case. Increasing OI amidst flat or decreasing TAbs
Net Pos would suggest a price move that is sustainable over both the
short-term and the long-term. Increasing OI amidst increasing TAbs
Net Pos suggests the market may be suffering the ills of speculative
excess over the short-term. Whereas the former scenario warrants
relatively small corrections in price action, the latter warrants more
intense corrections. [Box B provides 2 examples of application.]
CoT%C Studies
In addition to contemporaneous analysis, technical studies confirm the utility of CoT%C as a market timing device. Over the 13
year period between January 1986 and November 1998, a CoT%C or
CoT DI methodology outperformed a Buy and Hold Strategy for
bonds. Using a methodology similar to that used by Hayes (1994) in
studying the application of sentiment measures as market-timing devices, CoT%C outperformed both a Buy and Hold Strategy for bonds
as well as CoT%S and CoT%ST. My study applied volatility bands to
smoothed versions of the CoT%C, CoT%S, and CoT%ST time series
derived from the CoT Report and used violation of those bands to
generate buy and sell decisions in the US Treasury market over a 13
year period starting in January 1986 and ending in November 1998.
[see Appendix C for a discussion of the test methodology.] The output of this study is summarized in Table 1.
Table 1: Summary of CoT%C Study

HOLDING PERIOD RETURNS
.50 Std
.75 Std
1.0 Std
.75 Std
1.0 Std
CoT%C
46.1%
53.5%
41.4%
3.2%
3.7%
2.9%
CoT%S
25.9%
26.0%
21.7%
2.0%
2.0%
1.7%
CoT%ST
19.0%
43.6%
39.5%
1.5%
3.1%
2.8%
Buy & Hold
29.6%
AVG ANN COMP RETURNS
.50 Std
Barrie, Scott. The COT Index. Technical Analysis of Stocks &

Commodities. (September 1996).
Belveal, L. Dee. Charting Commodity Market Price Behavior (2nd
ed). Dow Jones-Irwin. Homewood, IL. 1985.
Bianco, James. Various Works. Bianco Research, L.L.C. [An Affiliate of Arbor Research & Trading , Inc.] Barrington, IL.
Hadady, R. Earl. Contrar y Opinion. How to Use It For Profits In
Trading Commodity Futures. Hadady Publications, Inc. Pasadena.
1983.
Hadady, R. Earl. The POI Index. Market Analysis via Price and
Open Interest Interaction. MTA Journal (May 1989). Market
Technicians Association, Inc. New York.
Hayes, Timothy W. Intermarket Sentiment: Using Sentiment in
One Market to Call Prices in Another. MTA Journal. (Winter
1994/Spring 1995). Market Technicians Association, Inc. New
York.
Hyerczyk, James A. Making a Commitment. Futures Magazine.
(November 1996).
Jiler, William L. Analysis of the CFTC Commitments of Traders
Reports Can Help You Forecast Futures Prices. 1985 Commodity
Year Book. Commodity Research Bureau. Jersey City. 1985.
Murphy, John J. Technical Analysis of the Futures Market: A Comprehensive Guide to Trading Methods and Applications. New York
Institute of Finance. New York. 1986.
Painter, William M. On Balance Open Interest Indicator. MTA
Journal. (Fall-Winter 1995). Market Technicians Association, Inc.
New York.
Shaleen, Kenneth H. Volume and Open Interest. Cutting Edge
Trading Strategies in the Futures Markets. Probus Publishing Company. Chicago. 1991.
BIOGRAPHY
Sal Greco, CFA, CMT is a Director of Fixed-Income Investments for the Metropolitan Life Insurance Company. He is the
Senior Market Strategist for the Department's Cross Sector Relative Group which addresses issues of asset allocation and relative
value across the company's portfolios. He is responsible for providing both fundamental and technical analyses on the domestic fixed-income markets, in addition to providing both shortand longer-term interest rate and yield curve forecasts for the
trading and portfolio management units of MetLife.
Mr. Greco is also the President of SG Research & Strategy,
L.L.C., a corporation he formed in 1995 to provide consulting
services, market analyses, and trading strategies to individuals
and institutions.
2.2%
Despite the usefulness of a CoT%C and TAbs Net Position methodology over the last several years, the methodology was misleading
at critical points in the 1990-93 Bull Market in bonds, and the Bear
Market which followed in 1994. During the former, the CoT% indicator kept one out of the Bull Market for a continuous 23 month
period. During the latter, it provided a timely sell signal early in 1994,
but reestablished an errant long position for six months in one of
the worst Bear Markets in a quarter century. This can be seen in
Exhibits C-2 and C-3 of Appendix C.
CONCLUSIONS
The analysis of OI under a Money Flow framework derives vital
sentiment information directly from the positions of participants in
a market. This internal, market-generated expression of sentiment
can be used in conjunction with the more popular survey-based, external sentiment measures to gain a more thorough understanding
of the underlying dynamics of the market and its price action.
Used in conjunction with traditional charting techniques, these
methodologies can add significant confirmation to an independent
price action analysis, while providing a quantifiable advantage for
market-timing purposes in the US Treasury market.
MTA JOURNAL
Spring-Summer 2001
15
Appendix A
ries. This results in the reporting of 9 specific cells or segments within

the CoT Report over time. [Figure A-1 presents the actual CoT Report for the period ending 12/29/98 as released through Bloomberg
Financial Markets.] In addition to the gross number of contracts
open, the CoT Report presents positions in 3 other ways: change in
OI since last report, as a percentage of total OI, and as number of
traders or accounts. Aside from the number of traders, the changes
and percentages are derived from the gross OI numbers reported at
the top of the report. Therefore, it is that first line of data in the CoT
report as shown in Exhibit A1 that is the most important.
THE CFTC COMMITMENT OF TRADERS REPORT

History
The CoT Report is a detailed accounting of total gross open positions in a given commodity, traded on a specific futures exchange
(ie. CBOT T-Bond Futures), categorized by account type. The CoT
Report was originated by the US Department of Agriculture (USDA)
in an attempt to differentiate between who was selling and who was
buying futures contracts. The Commodity Exchange Authority (CEA),
a division of the USDA, issued a monthly report which segregated
month-end OI into Reporting (large) and Non-Reporting (small and
foreign) traders. The Reporting category was divided again into
Commercial and Non-Commercial trading account categories. By
1976, the Commodity Futures Trading Commission (CFTC) assumed
responsibility for the CoT reporting mechanism in addition to expanding coverage into new futures markets. The CFTC published
the CoT Reports on a monthly basis until 1982, when they were discontinued for budgetary and reporting reasons. The reports resumed
in early 1983 and the CFTC expanded coverage once again to new
contracts in the rapidly growing futures markets. Between 1983 and
December 1990, the CFTC released the CoT Reports monthly on either the 11th day of the month or the first business day which followed, if the eleventh was a non-business day. Between January 1991
and October 1992, the CFTC published the CoT on a twice monthly
basis, reflecting OI holdings on the 15th of the month (or previous
trading day if the 15th was a holiday) and the last trading day of the
month. In October 1992, the CFTC began compiling the OI data
weekly, reflecting holdings as of the close on each Tuesday, releasing
the report every other Friday. This cycle remains in effect today.
Therefore, as it now exists, the CFTC CoT Reports are released every
other Friday, reporting OI positions on a weekly basis using the gross
open positions as of the close of each Tuesday.
Figure A-1
Table A1: Decomposition of CoT Report
LARGE
SMALL
Decomposition
The CoT Report decomposes OI into Total Gross Positions (long
and short) held by Reporting and Non-Reporting Accounts. All
clearing members of the exchange, futures commission merchants,
and foreign brokers on the exchange are required to make daily reports to the CFTC showing each of their customer accounts positions on their books, that in any contract month of a commodity,
exceeds the reporting level. If the accounts position does not exceed the reporting level, the aggregate positions of the customer accounts are classified as Non-Reporting for CoT purposes. If they exceed the reporting level, account positions are reported under the
Reporting categor y. [The current reporting level for Bonds is 500
contracts.]
The Reporting Categor y is further divided into Non-Commercial and Commercial categories. Non-Commercials, more commonly referred to as Speculators, are defined as accounts who have
positions in excess of the reporting limit, but do not take positions in
the commodities or securities underlying the futures contract. Commercials, more commonly known as Hedgers, are defined as accounts
whose positions exceed the reporting limit and take positions in the
cash commodities or securities underlying the futures contract. The
Non-Commercial category also contains the positions of Spreaders,
accounts that have offsetting (long and short) positions in different
contract months and do not hold positions in the cash commodity
underlying the futures contract.
The CoT Report provides a decompostion of gross open positions
(long and shorts) on a total basis as well as into each of these catego-
MTA JOURNAL
LONG
SHORT
NET
TOTAL
Comml
424,421
506,241
(81,820)
930,662
Spec
92,484
36,718
55,766
129,202
(NRPT)
91,287
65,233
26,054
156,520
Spreader
12,650
12,650
620,842
620,842
Total Absolute Net Positions
163,640
Open Interest
620,842
Spread Adj Open Interest
608,192
The definitions and terminology of the CoT report can be confusing, especially as released by most data vendors. It is more easily
understood in the context of Table A1, which re-orders the data provided in the raw report of Exhibit A1. Table A1 removes the Spreader
category from within the Non-Commercial category and shows it as
its own category. Representation of the CoT data in this form allows
greater clarity and is the basis for reformulation of the CoT data that
underlies the methodology and indicators I present. Table A2 more
clearly represents the percentage-based measures of positioning in
the CoT Report.
Total OI is defined as one-half of all open positions outstanding.
Thus, Total OI can be derived by summing all open long positions or
all open short positions in the market. As evident from Table A1,
total OI is equally represented by the sum of gross long positions or
gross short positions. By definition, the spreader component has an
equal number of open contract positions on the long and short side
of the market.
Spring-Summer 2001
16
Table A2: CoT Positions as % of Spread Adjusted OI

Large
Small
%Long
%Short
Comml
69.8%
83.2%
Spec
15.2%
6.0%
85.0%
89.3%
NRPT
15.0%
10.7%
100.0%
100.0%
Finally, the importance of Total Absolute Net Positions should be

immediately apparent. Although Net Positions will always sum to
zero, Total Absolute Net Positions will vary dramatically. [Total Absolute Net Positions in Table A1 are 163,640 cts. On a percentage
basis, that represents 27% of Spread Adj OI according to Table A2.]
Total Net Positions represent the degree of conflicting opinion in
the market, as it measures the difference from Neutral of each of the
three participants Net Positions. As Total Absolute Net Postions rise
on a percentage basis, the degree of conflict between the opinions of
the players is increasing. It is this degree of conflict that will eventually lead to a significant shift in sentiment (as OI is forced to decline)
and defines major turning points in the market. Thus, Total Absolute Positions provide a basis for deriving sentiment and applying the
principles of contrary opinion.
Several things should become apparent from these two tables.

First, despite the fact that total gross positions (long or short) may
differ greatly between participant categories, Net Position differences
between categories are relatively small. For example, Comml gross
long positions are 4.6x larger than Spec gross long positions, while
Comml gross short positions are 13.8 times larger than Spec gross
short positions. However, Comml Net Positions are only 1.5x Spec
Net Positions (on an absolute basis). A similar, but opposite situation exists between Specs and NRPT.
Second, the total Net Positions of all participants in a given futures market must sum to zero. The zero-sum nature of futures trading assures as much. This is the most basic identity property of OI
and the CoT Report. Every purchase of a futures contract must be
offset by a sale of that contract. Further, for every open position
established through a short futures sale transaction, there is an open
position established through a a long futures purchase transaction.
These two points form the basis of a Money Flow framework and underscore its differences versus a traditional Breadth framework.
Third, Spreader activity results in zero Net Positions, thus only
diluting the effect of Net Positions when they are represented on a
percentage basis. Further, the volatile and seasonal nature of spreading activity introduces unwanted noise into the OI figures for analysis purposes (Breadth or Money Flow). I utilize a measure of OI which
removes this component. I term this Spread Adjusted OI. It is derived
by summing Comml, Spec, and NRPT positions on either the long
or short side of the market. Alternatively, it can be derived by subtracting the Spreader component presented on the CoT Report from
Total OI.
Interpretation
The conventional wisdom offered by Belveal (1985) and Jiler (1985)
suggests the LT component of the CoT will outperform the ST component; and that Comml can be expected to outperform Specs. Rather
than address interpretation from the LT v. ST or Comml v. Spec division, it is more valuable to do so from a more generic strong-hand
vs. weak-hand perspective. This avoids the differences between
Comml and Specs that invariably occurs across markets.
Commls represent the strong hands of the market versus the weak
hand of the Spec or NRPT Trader, due to their superior market experience and financial strength. Further, the Comml has qualities
of judgment, experience, and adequate capitalization (Belveal, p
42) which makes him/her a strong hand.
Specifically, Belveal cites many factors that allow Commercials or
Hedgers to represent and maintain the strong hand in the commodity futures market. Because they are not limited by position limits
and have business requirements and the financial wherewithal to buy
or sell in multiples of contract size or market depth, the commercials
are the 100 pound gorilla. The commercial/hedgers proprietary
interest in the underlying commodity allows him/her to conduct defensive buying or selling when price changes appear to threaten his/
hers interests. Finally, the necessity of having to transact in all market conditions and all price ranges makes the Commercial/Hedger
one of the best analysts his/hers market could have. Commercial
players are always faced with the need to sell in low-priced markets
and buy in high-priced markets. In fact, they are often forced to do
one only days or weeks after doing the other. Further, the on-going
nature of hedging operations/activities among commercial accounts
attest to their profitability. If it were otherwise, hedging programs
could not be justified and would rightly be abandoned by the Commercial players inside a market.
Small Traders (NRPT) and Specs are undercapitalized and lack
the information and experience of the larger Commercials. Belveal
sums up their weak-handed nature quite simply: The weak hands
are weak not because they are likely to be wrong in their judgment,
but because they perform so badly in the face of vicissitude. (p. 151)
Such interpretations of positioning among categories of traders
give the decomposition and derivations of the CoT Report a logical
and applicable anecdotal basis for application.
Open Interest =
Comml Long + Spec Long + NRPT Long + Spread Long
or
Comml Short + Spec Short + NRPT Short + Spread Short
Spread Adjusted OI =
Comml Long + Spec Long + NRPT Long
or
Comml Short + Spec Short + NRPT Short
or
Total Open Interest - Spreading OI
Total Absolute Net Positions=
|Net Comml Pos| + |Net Spec Pos| + |Net NRPT Pos|
Fourth, because the sum of total Net Positions must equal zero,
the sum of the Net Position of any two of the trader categories must
be equal in magnitude but opposite in sign to the third category.
This is a corollary to the tenet that Net Open Positions must sum to
zero. However it is often the case but not the rule that the same
two categories will offset the third category especially when Total
Absolute Net Postions are high. For example, 63% of the 482 weekly
observations from the CoT Report for Bonds, Specs were aligned on
the same side of the market (short v. Long) with NRPT.
MTA JOURNAL
Spring-Summer 2001
17
Appendix B
Appendix C
ALGEBRAIC DERIVATION OF A COT DIFFUSION INDEX
TESTING METHODOLOGY
The identity properties of the CoT Report assure that the sum of
two of the three components (Comml, Spec, ST) will be equal in
magnitude but opposite in sign to the third component.
In order to assess the utility of CoT derived series as market-timing tools, I conducted a study using a methodology similar to that
used by Hayes (1994). [Hayes used weekly Market Vane Sentiment data
from three markets (Gold, Bonds, and Stocks) to generate Buy and Sell signals
in - and across - those markets to determine if an active contrary opinion
investment style outperformed passive Buy and Hold Strategies.] My objective was to determine if an active contrary investment style using the
3 component series I derived from the CoT Report for Bonds
(CoT%C, CoT%S, CoT%ST) outperformed a passive Buy and Hold
strategy for Bonds over the preceding 12 years, and whether one series proved superior to another.
The data requirements for this study were quite simple. The
CoT%C, CoT%S, and CoT%ST series were derived from CFTC data
downloaded from Bloomberg and the CFTC database. The data is
clean and reliable. Daily closing prices for the nearby Bond Future
were taken directly from the Chicago Board of Trade (CBOT) database and from Bloomberg. That information was reviewed and found
to be clean and reliable. Weekly close observations were chosen so
that the pricing day corresponded to the last day covered by each of
the CoT Reports, or to the day closest to the last day covered by the
CoT release. There was no constraint that prices be executable,
since the goal of the study was to determine whether a contrary relationship between Bond prices and CoT Position data existed. The
construction of a trading system was not a goal, so the constraints of
trading system design were not applied.
First, a smoothed version of all three CoT indicators was obtained
by deriving 13-week moving averages of the raw CoT%C, CoT%S,
and CoT%ST time series from the CoT data. Second, volatility bands
were generated at three standard deviation magnitudes (.50, .75, 1.0)
around a 13-week moving average of each of the originally smoothed
data. Third, buy and sell signals were generated only after the
smoothed data moved through a band, reached an extreme, and then
reversed back through the same band. Exhibit C-1 shows the smoothed
data series for CoT%C and the volatility bands generated at a 1.0 Std
level.
Since the CoT%C sentiment series represents strong hands or
smart money, a buy signal is generated when CoT%C moves below the
upper band after violating it on a move to an extreme positive reading.
A sell signal is generated when CoT%C moves above its lower band
after violating it on a move to an extreme negative reading.
The CoT%S and CoT%ST series represent weak hands or dumb
money. Therefore, a buy signal is generated when the smoothed CoT%S
and CoT%ST series move above the lower volatility band after violating
it on the way to a an extreme negative reading. A sell signal is generated
when the smoothed series moves below the upper band after violating it
on a move to an extreme positive reading.
The assumption underlying the model is simple. $1.0 mm is available on 1/2/87. A Buy and Hold strategy is represented by purchase
of a 1 mm Par Bond at the closing price of that day, held over the
entire period, and valued at the closing price on the last day of the
study. The active management style was driven by Buy and Sell signals generated from our three CoT derived sentiment series and their
volatility bands. The $1.0 mm opening balance remained in cash
until a Buy signal was generated by the model. The model was in
Neutral mode at the start of the study period.
Exhibit C-2 displays the price action of the Nearby Bond Future
along with the Buy and Sell signals generated by the CoT%C series at
CoT%C = (CoT%S + CoT%ST) * (-1)

CoT%S = (CoT%C + CoT%ST) * (-1)
CoT%ST = (CoT%C + CoT%S) * (-1)
The identity properties can be algebraically manipulated to prove
that the CoT Diffusion Index (DI) is another form of the CoT%C
equation. The DI will always be equal to two times CoT%C. The
methodology of the study conducted upon CoT%C, CoT%S and
CoT%ST will assure equivalent output between CoT%C, CoT%Fade,
and CoT DI. Although their absolute levels may differ, they are equivalent on a relative or proportional basis.
Definintion: CoT DI = CoT%C - CoT%S - CoT%ST
Since, CoT%C = (CoT%S + CoT%ST) * -1, then....
CoT%C - CoT%S - CoT%ST = ((CoT%S + CoT%ST) * -1) - CoT%S - CoT%ST
CoT%C - CoT%S - CoT%ST = - CoT%S - CoT%ST - CoT%S - CoT%ST
CoT%C - CoT%S - CoT%ST = - 2CoT%S - 2CoT%ST
CoT%C - CoT%S - CoT%ST = - 2 * (CoT%S + CoT%ST)
- 1 * (CoT%C - CoT%S - CoT%ST) / 2 = (CoT%S + CoT%ST)
Since, CoT%S + CoT%ST) = CoT%C * -1, then ...
-1/2 * CoT Diffusion Index = CoT%C * (-1), and ...
CoT Diffusion Index = 2 * CoT%C , or ....
CoT%C = 1/2 * CoT Diffusion Index
MTA JOURNAL
Spring-Summer 2001
18
Exhibit C-1
the 1.0 std band level. It outperformed a Buy and Hold Strategy over
the the 12 year period by 1180 bps, or approximately 290 bps on an
annually compounded basis. Table C-1 summarizes the output for all
three data series at all three std levels. [This table also appears in the
body of the text as Table 1.]
An active CoT%C strategy would have outperformed a Buy and
Hold Strategy over the 1986 to 1998 period, suggesting that CoT%C
is a valid sentiment indicator, and that a Money Flow framework for
OI Analysis can improve market timing decisions in the Treasury market. Further, the CoT%C appears superior to both the CoT%S and
CoT%ST series. This supports the contention that CoT%C - and its
many equivalents - is the broadest and most accurate decomposition
of the CoT data.
However, two things should be noted in regard to the application
of this methodology. First, the output exhibits significant variance
Std magnitudes. In fact at higher levels of Std (>1.0), none of the
series returned profitable results versus a Buy and Hold strategy. This
is a result of timing sensitivity. Clearly, marginal differences in timing of Buys and Sells can change the results dramatically. Since Bond
prices can change dramatically week to week, small differences between signals and market highs and lows can inject a considerable
amount of variance into this type of study. Exhibit C-3 lists the Buy
and Sell signals for each series at each Std level.
Exhibit C-2
Table C-1: Summary of CoT%C Study

HOLDING PERIOD RETURNS
AVG ANN COMP RETURNS
.50 Std
.75 Std
1.0 Std
.50 Std
.75 Std
CoT%C
46.1%
53.5%
41.4%
3.2%
3.7%
2.9%
CoT%S
25.9%
26.0%
21.7%
2.0%
2.0%
1.7%
CoT%ST
19.0%
43.6%
39.5%
1.5%
3.1%
2.8%
Buy & Hold
29.6%
1.0 Std
2.2%
Exhibit C-3
MTA JOURNAL
Spring-Summer 2001
19
APPLYING VODOPICH'S INTEGRATION OF ELLIOTT AND GANN TO THE

LONG-TERM STUDY OF THE DOW JONES INDUSTRIAL AVERAGE
Blethyn Hulton
INTRODUCTION
enduring value of a Gann line is its slope (rise/run, or number of

points per trading period), which is determined for each tradable
based on historical observation, or in Vodopichs words, The proper
scale Gann line work is one which has worked in the past.1 Appendix 1 reproduces Gann-line slopes of various tradables, as determined
by Vodopich and John Murphy in their respective works.
In Trading For Profit With Precision Timing, Don Vodopich enhances the
analysis of Elliott Waves by attaching Gann lines to wave starting points.
With this approach, Vodopich studies a variety of futures markets in the shortterm as is appropriate for trading. The purpose of this research is to apply
Vodopichs technique to the long-term study of the stock market, specifically the
Dow Jones Industrial Average (DJIA), which was the focus of Elliotts work.
The period covered is Supercycle Wave (V) as counted by Frost & Prechter,
which began in 1932. The Vodopich analysis breaks down the present cycle of
Cycle-degree (i.e., Supercycle Wave (V)) as well as certain Primary, Intermediate, and Minor cycles within it.
AMENDMENT TO VODOPICHS METHOD

The author has changed the practice of Vodopichs approach in
four ways; generally, the changes relax some of the original rules,
improving their application to the study of the stock market. The
first change is to start the Gann line at the beginning of wave 3 rather
than wave 1. In the stock market, the thorough retracement of wave
2 would most often slice through any line started at the beginning of
wave 1; and as a result, the Gann line would not as effectively indicate
support through wave 3. The second change is to accept, using analytic judgment, a Gann-line slope which varies from that dictated by
historical observation. As will become evident in the examples,
Vodopichs method is more useful during the more volatile 5th wave
than in the 3rd wave. A wave 3 is so strong that it does not need as
much analytic aid; and so the author works with trial-and-error during wave 3 to find the line that will work for him thereafter, in waves
4 and 5. The third change is to allow the slope of a component wave
to be a round multiple (e.g, 1.5x, 2x, 2.5x) of the parent wave, not
necessarily an integer multiple. And finally, the author views the
Vodopich convergence to be not the end of the trend, but rather a
point in time and/or price where the reward/risk ratio drops dramatically. As the examples will demonstrate, the momentum built
up through wave 5 may well carr y price beyond the intersection of
the Gann lines; and if price stalls there, the market may trade sideways before reaching a new high. In either case, the reward/risk
ratio falls, suggesting a change in asset allocation. And the Vodopich
convergence alerts one to the greater risk as well as the prospect of a
reversal.
BACKGROUND
Vodopich argues that the slope of the line from the start of an
impulse wave to its end can be known in advance because the slope
is particular to the tradable.1 For example, the slope of an impulse
wave of several months length in T Bond futures always has a slope
of .10 points (about 3 ticks) per trading day. Such a line is a Gann
line since unlike a trendline its slope can be known at its starting
point, but like a trendline it identifies support and resistance. Chart
1 demonstrates how such a Gann line attached to an impulse wave
might work in theory. The Gann line would indicate support up
through the top of impulse wave 3, would be firmly broken by wave 4,
and would indicate resistance thereafter up to the end of the impulse wave, the end of wave 5.
Chart 1
Gann Lines Drawn Onto Elliott Impluse Wave
Chart 2
T Bond Futures Contract from April '97 to January '98
In Vodopichs work, the slope of the Gann line belonging to any

component wave is an integer multiple of the slope of its parent.
Further, as Chart 1 shows, the Gann lines of various fifth waves of
lesser degrees intersect the parent wave at its end; this intersection is
labelled a Vodopich Convergence in Chart 1.
Vodopich analyzes both impulse and corrective Elliott waves with
Gann lines, but this study examines only impulse waves since longterm stock market moves are such waves. Gann lines have traditionally been associated with particular angles, such as 45 degrees; but
this is a carryover from the days of manual charting. The angle of a
trendline depends on the aspect ratio of the chart and how price and
time are scaled. In the electronic era, when most charts conform to
the aspect ratio of the computer screen or the laser-printed page, the
MTA JOURNAL
Chart 2 demonstrates an amended Vodopich analysis of T Bond

futures from April 97 through January 98; the chart plots the 12/97
contract through November 97 and the 3/98 contract thereafter.
The impulse wave begins at the 4/11/97 low of 105.788; but the first
Gann line, with a slope of .10 points/trading day, is drawn from the
Spring-Summer 2001
20
start of wave 3 at 107.75 on 5/27. Inspecting the chart, one can see
that the .10 line did reveal support up through the wave 3 top on
8/1, capturing the late June correction. Note that a line drawn from
the beginning of wave 1 with the same slope would have sliced through
the ensuing rally, rendering the Gann line useless.
Wave 4 of this rally ended at the 8/26 low of 111.438, firmly breaking the .10 line. Both during wave 4 and after, this same line identified resistance until January 98. The second Gann line begins the
3rd wave within wave 5, at the 9/11 low of 111.938. It has a slope of
.15 points per trading day, 1.5x the slope of the line attached to the
parent wave. The .15 line indicated support through late November 97. After that line was firmly broken by the 4th wave within wave
5, the last Gann line was drawn from the low of 117.78 1 on 12/9/97
(using the 3/98 contract). The slope chosen for this line was .20
points per day, 2x the slope of the original Gann line and 1.33x the
slope of the second line. This slope is chosen in part because it directs the line to the intersection of the first and second Gann lines.
This intersection, a Vodopich convergence, at 124.5 in mid-January
1998, is near the intraday high of 124.28 on 1/12/98 (using the 3/98
T Bond futures contract), which remained the high for several
months.
This demonstration of Vodopichs integration of Elliott and Gann
supports its theoretical argument, that an Elliott impulse wave is associated with a Gann line whose slope has worked for the tradable
in the past1; that Gann lines of component waves have slopes that
are round multiples of the slope of the parent wave; that these Gann
lines indicate support through wave 3 and resistance thereafter; and
that the Vodopich convergence, the intersection of the Gann lines,
identifies a point in time/and or price (both time and price in this
case) at which the reward/risk ratio drops substantially. Appendix 2
contains the dates and prices of the Elliott waves discussed above with
relevant Fibonacci ratios.
Readers familiar with the T Bond action in 1998 know that after
the January high, T-Bonds corrected until April 98 and then rallied
to a historic high in October. This price movement raises the question whether there was a larger cycle operating which this Vodopich
analysis did not capture. The issue of a hierarchy of cycles is central
to the long-term Elliott Wave analysis of the stock market, the focus
of this research and of Elliotts original study.
expressed in relative, percentage change rather than absolute point

change just as such charts plot price on a logarithmic scale rather
than a linear scale3; and all percent slopes discussed here are annually compounded. As the reader will see, the slope of the Gann line
for the largest cycle under study (the cycle of Cycle-degree) is 8.5%
per year, and the slopes of the Gann lines for all component waves
are round multiples of that. A final note is that for the highs and
lows in the DJIA used to mark the endpoints of waves, theoretical
highs and lows are reported before May 1991 and actual highs and
lows thereafter.
Table 1
Frost & Prechter's Count of Millennial, Century and
Generational Waves
THE PRESENT MINUTE CYCLE (MINOR CYCLE WAVE

5) - THE BULL MARKET FROM 1994 TO THE PRESENT
Chart 3 plots weekly bars of the bull market from March 94
through March 98. This bull market, which corresponds to Minor
Cycle Wave 5, has a Gann-line slope of 34% per year, 4x the slope of
Supercycle Wave (V). Although the Minute Cycle began at the 4/4/
94 low of Dow 3552.47, the Gann line begins at Wave iii, 3638.62 on
11/23/94; and as Gann lines should, this line indicated support until
the Wave iii top of 5796.10 on 5/23/96.
After the 34% line was firmly broken in the mid-96 correction,
Wave v began (Wave iv ended) at Dow 5182.31 on 7/16/96. The
second Gann line starts at the beginning of Wave 3 within v, at 5561.46
on 9/3/96, drawn with a slope of 51% per year, 1.5x the slope of the
first Gann line (its parent wave) and 6x the slope of 8.5%. Note that
as Vodopichs method would indicate, price rose during Wave 3 within
5 in between the first, 34% line, indicating resistance, and the second, 51% line, indicating support. Price broke the support of the
second Gann line after the top of Wave 3 within 5, at Dow 7112.10 on
3/11/97. The third and final Gann line of this Minute Cycle (Minor
Cycle Wave 5) is drawn from the 6356.77 low on 4/14/97, which corresponds to the beginning of the Wave iii within 5 within v. The
slope of this line is 102% per year, 2x the slope of the second Gann
line drawn for this cycle and 3x the first. Appendix 3 contains the
dates and prices of the Elliott waves discussed above with relevant
Fibonacci ratios.
APPLYING GANN TO LONG-TERM BULL MARKETS

Referring to a hierarchy of cycles in the Elliott Wave, Frost &
Precther stated that as far as we can determine, then, all waves both
have and are component waves.2 Frost & Prechter demonstrated
this idea with the Dow Jones Industrial Average, and Table 1 lists
their hierarchy of waves as well as the labelling of those waves to be
discussed here. If one combines Elliotts argument for a complete
hierarchy of waves with Vodopichs argument that for any target
wave the Gann-line slopes of component waves are round multiples
of the Gann-lines slope for the target wave, then with any one impulse-wave Gann line, one should be able to find the Gann-line slopes
for all parent and component waves throughout the hierarchy.
In search of these Gann lines, this research examines Primary,
Intermediate, Minor, and Minute cycles from 1945 to 1997, beginning with the present Minute cycle, which began in 1994. This presentation departs from the standard Elliott Wave analysis, which is to
work inward from the parent wave to the component waves, in order
to highlight the current cycle, with which readers are most familiar.
The largest cycle under study, the cycle of Cycle-degree from the 1932
low, will be presented last.
Since this is a long-term study of the Dow, Gann-line slopes are
MTA JOURNAL
Spring-Summer 2001
21
Chart 3
The Present Minute Cycle (Minor Cycle Wave 5)
Dow Jones Industrial Average from 1994-1997
Price firmly breaking the Gann line (as the July 96 correction
broke the 34% line) is reason to suspect a wave 4 correction. Upon
resumption of the uptrend, one draws the second Gann line, repeating the evaluative process that led to the first. Now, however, during
the wave 3rd wave within the 5th wave, one watches for the second
Gann line to indicate support while the first line indicates resistance;
and this happened in Minor Cycle Wave 5 from September 96
through March 97. With the third Gann line, drawn after the second is broken, one is approaching either the end of the impulse wave,
or, as is the case in Chart 3, a significant change in trend, reducing
the reward/risk ratio. The third Gann line confirms the intersection
of the first two; and as price approaches the Vodopich convergence,
one can adjust ones equity exposure for the expected higher volatility and lower reward/risk ratio.
The Vodopich convergence is not a reversal signal. As has been
discussed in the T Bond futures represented in Chart 2 as well as the
U.S. equity bull markets shown in Charts 3 and 5, more often than
not, the trend resumes after a Vodopich convergence, albeit with
greater volatility and after some consolidation. This likelihood points
out a limitation in the authors use of Vodopichs integration of Elliott and Gann, since the addition of Gann lines leaves part of the
impulse wave unmeasured. An addendum to this paper examining
the price action from August 97 to the present addresses the question of how to analyze such price action.
In summary, Chart 3 demonstrates a Vodopich analysis of a longterm (32 month) Elliott impulse wave of the Dow. The first and second Gann lines, at 34%/yr. and 51%/yr., indicate support through
the 3rd wave of their cycle and resistance thereafter. However, the
third Gann line, the 102% line, performed differently from the
first two, indicating support through the 3rd wave but never resistance. All three lines intersected in late July 97, near the 8/7/97
high of 8299.49. And while this Vodopich convergence did not mark
the absolute high, it did indicate the time and price after which price
movement became more volatile. The Dow did not break the 8299
high for six months, in February 98; and from August 97 through
August 98, the Dow suffered two significant corrections, -16% in
October 97 and -21% in July/August 98.
The discussion of Minor Cycle Wave 5 is also a practical example
of how one applies Elliott and Gann to long-term stock market impulse waves. Early into what one believes is a 3rd impulse wave, early
1995 for the cycle in Chart 3, one draws a Gann line whose slope is a
round multiple of the slope of the parent-wave Gann line; at the time,
this is an academic exercise since the Gann line does nothing to establish that the cycle has begun its 3rd wave. The inability of a Gann
line to contribute to the assessment of a 3rd wave is no drawback
since 3rd waves are the easiest of all waves to spot. In the words of
Frost & Prechter, Third waves are wonders to behold. They are strong
and broad, and the trend at this point is unmistakable. Increasingly
favorable fundamentals enter the picture as confidence returns . . . .
Such points invariably produce breakouts, continuation gaps, volume expansions, exceptional breadth, major Dow Theory trend confirmations and runaway price movement.4
Relying on other measures, then, to validate the wave 3, one can
experiment with Gann lines of two or three different slopes (e.g.,
1.5x, 2x, 2.5x the slope of the parent wave) to find the line that best
indicates support. In the latter half of a 3rd wave, in late 1995 for
Minor Cycle Wave 5, one should expect to find the single Gann line
that best indicates support through the 3rd wave. The analyst must
be careful not to create a Gann line that is too tight, whose slope is
too steep; such a line probably belongs to the 3rd wave within wave 3,
not wave 3 overall. To check that the Gann line chosen is proper
and not too steep, the author draws a price channel, using the Gann
line as its lower boundary. The usefulness of this technique is based
on the authors observation that price channels are common and
easy to see in 3rd waves.
MTA JOURNAL
THE CURRENT PRIMARY C YCLE (CYCLE WAVE V) THE BULL MARKET FROM 1974
Chart 4 plots monthly bars of the DJIA from the 1974 low through
March 1998 and indicates the particular wave count for this Primary
cycle which the Vodopich analysis suggests. For reference, note that
Chart 3 (covering the period from 1994 onward) fits in the upper
right hand corner of Chart 4. Note also that the 34% line in Chart
4 is the same line of the same slope from Chart 3. The Vodopich
analysis of this period leads to a different wave count than that suggested by Frost & Prechter5; and that wave count, in turn, leads to
two important conclusions. The Vodopich analysis suggests first that
the entire period from 1982 to the present is Primary Cycle Wave
((3)) and second that the 1990 high, not the 1987 high, was the top
of Intermediate Wave (3) within ((3)). The argument here for the
revised wave count is one of fit rather than proof. The explanation fits the market action to date. However, it does not provide a
perfect Elliott wave count, nor is it the necessarily the count that
would have presented itself at various times in the past.
In this count, the Primary Cycle (Cycle-degree Cycle Wave V) begins at the 12/9/74 low; and the first Gann line, with a slope of 12.75%,
begins at the 8/31/82 low of 769.98, which in this count represents
the start of Primary Wave ((3)). Here again, the integration of Elliott and Gann is iterative; neither the wave count nor the Gann line
were fixed before adding the other. The choice for the Gann-line
slope and the start-date for drawing it (with the wave count implied
by this choice) are made in an effort to find the best wave count and
Gann line for the price action that followed.
What is fixed in a Vodopich analysis is that the Gann lines slope
must be a round multiple of the Gann-line slope of the parent wave
(12.75%/yr = 1.5 x 8.5%/yr.) and that the Gann line indicates support until it is firmly broken by the 4th wave in the cycle, wave ((4))
in this case. As one can see from Chart 4, the 12.75% line has
remained consistently beneath the market lows after 1982, i.e., the
lows in 1984, 1987, 1990, and 1994.
Spring-Summer 2001
22
Chart 4
The Current Primary Cycle
(Primary Waves ((1)) through ((3)) Cycle-degree Cycle Wave V)
Dow Jones Industrial Average from 1974-1997
Table 2
Projections of Gann Lines to August 7, 1997 and
Comparison with Actual High for Dow Jones Industrial Average
There is no satisfactory Vodopich breakdown of Intermediate Wave

(5), the bull market from 1990 to the present; a wave count for Wave
(5) is included in Appendix 4 with relevant Fibonacci ratios. Wave
(5) is different in that it is concave. In the authors observation, it is
more common for an impulse wave to look convex, to bow upward,
because the 3rd wave advances strongly with less volatility than the
5th wave; and it is this convexity that allows a Gann line to indicate
support through the third impulse wave and resistance thereafter. In
Intermediate wave (5), price advanced +70.0% through the top of
Minor wave 3 in January 1994; but from that top of Dow 3985.95,
price advanced more, +108%, through the 8/7/97 top of 8299.49.
This anomaly is consistent with the unusual economic recovery in
the U.S. after the 1991 recession. The postrecession earnings boom
did not come in 1991 and 1992 as would normally be the case; the
boom came in 1994 through 1997.6 And the early, slow advance in
stock prices reflected the early, modest growth in earnings.
A wave count of the Intermediate Cycle within Primary Wave ((3))

supports the authors argument for the parent-wave count and is included in Chart 4. A Gann line with a slope of 17%/yr. begins at the
7/25/84 low of Dow 1078.9, which starts Intermediate Wave (3) within
Primary Wave ((3)). The slope of the line is 2x the slope of Supercycle
Wave V (8.5%/yr.) and 1.33 x 12.75%, the slope of the parent wave,
Primary Wave ((3)). Further, the Gann line indicates support for
the price movement up to a certain point, the 1990 top. However, it
does not indicate meaningful resistance thereafter; price remains well
under the 17% line between 1990 and 1997. (The importance of
the 17% line is discussed later).
In the wave count implied by this Gann line, the 1990 top, not the
1987 top, represents the end of Intermediate Wave (3), thereby lowering the significance of the 1987 crash by one degree in the Elliott
wave count. This wave count finds validity in the following Fibonacci
ratios. The ratio of Wave (3) to Wave (1) is 2.63 (+180.3%:+68.7%);
and within Wave (3), the ratio of Wave 5 to Wave 3 is .63 (+87.1%:
+137.9%). This wave count is unusual in that the high of wave 5
(Dow 3024.30) was not much beyond the high of wave 3 (2746.65 in
August 87). However, the Vodopich analysis of the T Bond futures
contract yields a wave count that is similar in that the later, marginal
high with the less dramatic correction emerges as the 3rd wave top.
In Chart 2, the marginal high in November immediately precedes
the breaking of the Gann line, thereby suggesting the wave 3 top,
even though a more dramatic correction followed the slightly lower
October high. The final point to support the argument for the 1990
top as the end of wave (3) is that the 1990 correction (Intermediate
Wave (4) in this count) corresponded to a larger economic phenomenon, the 1991 recession. Appendix 4 contains the dates and prices
of the Elliott waves discussed above, Primary Wave ((3)) and Intermediate Wave (3), with relevant Fibonacci ratios.
Further, as one can see in the upper right hand corner of Chart 4,
the 17% line intersects two other lines, the 34% line (the same
34% line from Chart 3) and the line labelled 8.5%/yr. The 8.5%
line is the Gann line drawn from the 1942 low; and it contributes to
a Vodopich convergence, an intersection of two or more Gann lines,
around the time and price of the same Vodopich convergence in Chart
3, occurring near the Dows 1997 high of 8299.49 on 8/7/97. As one
can see in Table 2, which projects the five Gann lines to 8/7/97, all
price projections are within .32% to 3.24% of the actual high. The
accuracy of these projections, based on five Dow prices from 1942 to
1997, demonstrates the insight gained from adding Gann lines to
long-term Elliott impulse waves.
MTA JOURNAL
PRIMARY CYCLE (CYCLE WAVE III) - THE BULL

MARKET FROM 1942 TO 1972
Chart 5
The Primary Cycle from 1942-1972 (Cycle-degree cycle Wave III)
Dow Jones Industrial Average
Chart 5 plots monthly bars of the DJIA from 1942 to 1972, the
bull market between World War II and the Vietnam War; and the
Vodopich analysis confirms Frost & Prechters wave count for this
period (Cycle Wave III).7 Wave III of Supercycle Wave (V) began at
the 4/28/42 low of Dow 92.92; and from here the Gann line with the
slope of 8.5%/yr. is drawn. This line clips the 6/13/49 low of 161.5,
which marks the start of Primary Wave ((3)) within Cycle Wave III.
And from this point, a Gann line is drawn with a slope of 12.75%/yr.,
1.5 x 8.5%/yr., the slope of the parent wave. The 12.75% line indicates support during Wave ((3)), capturing the pullbacks in 1953
and 1957, until it is broken in the early 1960s. In this way, the 12.75%
Spring-Summer 2001
23
line validates Frost & Prechters count of the Wave ((3)) top in 1958.7
The second Gann line for Cycle Wave III is drawn from the start
of Wave (3) within ((5)), at 558.06 on 10/32/62. Its slope of 25.5%/
yr. is 2x the slope of the Gann line of the parent wave, and 3x the
slope of 8.5%, the slope of the grandparent wave, Cycle Wave III.
This second Gann line behaves as a third Gann line often does, not
indicating resistance once broken; and no third Gann line emerges
from the analysis of this period to confirm the intersection of the
first two. The first two lines do intersect in early 1966 around Dow
1250, and this marked Frost & Prechters Cycle Wave III top in time
but not in price.
Here again, the Vodopich convergence does not signal a reversal
but rather the beginning of a period in which volatility increases substantially with some advance in price. The 1973 Dow peak of 1051.7
exceeds the 1966 peak by 5.7%; but in between the peaks the Dow
suffers two corrections, -25% in 1966 and -36% in 1968-70. Frost &
Prechters use of complex wave patterns to analyze this period is taken
as support for the argument that the portion of a trend after the
Vodopich convergence is inherently more difficult to analyze with
the Elliott Wave. To analyze the time from 1966 to 1982, Frost &
Prechters original (1978) count labels the period from 1966 to 1974
as an expanding triangle; but in 1982, Prechter favored a doublethree wave count, ending Cycle Wave IV in 1982.5
An addendum to this paper analyzes the Dow following the
Vodopich convergence in August 97. In this real-time post-convergence analysis, the author will suggest how to deal with such a period.
The first two Gann lines in Chart 6 intersect at Dow 29,000 in

2012, and this intersection represents a price and/or time target for
Supercycle Wave (V). This target is not necessarily the end of the
cycle. In Charts 2 through 5, price continued to rise or trend sideways after a Vodopich convergence. However, in all cases the volatility also increased dramatically, reducing the reward/risk ratio substantially; regardless of the price movement after 2012, one can expect much higher volatility, frustrating long-term market analysis.
This Wave (V) target differs from H. S. Dents projection in The
Roaring 2000s of Dow 35,000 in 2008 for a methodological reason.
In the chart with the 35,000 target, Dent has drawn a trendline with
about the same slope as the 12.75% line in Chart 6, although Dent
starts the line from the September 84 low, not the September 82
low used here. His 35,000 target comes from a parallel, channel line
from the 1987 high, projected to 2008, the time of the market peak
suggested by his demographic analysis.8 The methodological difference between Dents forecast and the one suggested here is that Dent
believes that the price channel, bound underneath by the trendline
similar to the 12.75% line, continues until the market top. The
Vodopich analysis concludes that the trendline will be broken by the
4th wave, Primary Wave ((4)), and that once broken it will serve as
resistance during the 5th wave, Primary Wave ((5)). As resistance
then, the 12.75% line marks the upper boundary of price movement, not the lower boundary, as it seems to for Dent.
Chart 6 includes a third Gann line, sloping upwards towards Dow
29,000 in 2012 at the compound annual rate of 25.5%. Since the
Dow has yet to complete Primary Wave ((3)), this is a tentative Gann
line for Primary Wave ((5)); its purpose is to outline a possible scenario for the final wave. The slope of the line is 2x the slope of the
Gann line of the parent wave, Cycle Wave V, and 3x the slope of the
grandparent wave, Supercycle Wave (V). As incredible as it might
be to think of the stock market rising 25% per year for several years,
Chart 3, charting the Dow from 1994, shows periods when the market advanced at a faster pace. Further, in the 1920s, the Dow rose
24.9% per year (compounded) from the August 21 lowest close of
63.90 to the September 29 highest close of 381.17. Thus, it is important to be open minded to the prospect of the market scoring 20%
plus annual returns before dividends during the next decade. Further, as has been shown in other charts, one can expect the slopes of
component waves to be round multiples of the slope of Primary Wave
((5)). For example, using a base slope of 25.5%/yr., the Gann line of
Intermediate Wave (3) within Wave ((5)) might have a slope of
38.25%/yr. (1.5x 25.5%/yr).
The long-term application of Vodopichs integration of Elliott and
Gann has ignored corrective waves because the author has not found
a consistent methodology for them; as a result there is no means in
this analysis to measure how far Primary Wave ((4)) might run. Frost
& Prechters guideline is that corrections, especially when they are
fourth waves, tend to register their maximum retracement within the
span of travel of the previous fourth wave of one lesser degree, most
commonly near the level of its terminus.9 In the Elliott Wave count
presented here, Frost & Prechters guideline suggests that Primary
Wave ((4)) will end in the range of Intermediate Wave (4) of ((3))
(the 1990 correction), Dow 2344.31 to 3024.26.
This target for Primary wave ((4)) and the 25.5% line from Chart
6 come together in 2002, which is also the bottom of the next 4-year
cycle.10 Note that this intersection represents the start of Intermediate Wave (3) within ((5)). Primary Wave ((4))would end, in this
scenario, in 2000 or 2001, followed by Intermediate Waves (1) and
(2) of ((5)).
THE CURRENT CYCLE OF CYCLE-DEGREE

(SUPERCYCLE WAVE (V) ) THE BULL MARKET FROM 1932 TO THE PRESENT
Chart 6
The Bull Market from 1932-Present
Dow Jones Industrial Average
Chart 6 plots quarterly (3 month) bars of the Dow Jones Industrial Average from 1910 to the present along with three Gann lines
and Cycle Wave turning points. The first two Gann lines, with slopes
of 8.5% and 12.75%, are identical to the lines with the same slopes in
Charts 5 and 4 respectively. As one can see in Chart 6, the Gann lines
applied to the Dow from World War II onward indicate support and
resistance in the same manner as Gann lines in Charts 2 through 4.
The first Gann-line, the 8.5% line, indicates support through Cycle
Wave III; this line is firmly broken by Cycle Wave IV; but the line does
not indicate any meaningful resistance until the summer of 1997, as
has been discussed previously.
MTA JOURNAL
Spring-Summer 2001
24
SUMMARY
The post-convergence period in the Original Addendum Chart

differs from the similar period in Chart 5 in that the Dow rises substantially after August 97, but price does not do so after the 1966
high. The current advance in price biases the analysis in favor of an
impulse wave count rather than a corrective wave count, such as the
one used by Frost & Prechter for 1966 to 1982.5
The purpose of this research has been to apply Vodopichs integration of Elliott and Gann to the study of long-term impulse waves
in the Dow Jones Industrial Average. The effectiveness of such an
analysis can be seen by comparing Charts 1 and 6. Chart 1 shows how
Gann lines should help a wave count; and Chart 6, the DJIA after
World War II with Gann lines based on percentage slopes, delineates
a credible wave count for Supercycle Wave (V) and targets its top.
Drawing Gann lines from Elliott Wave starting points can help select
the best among alternative wave counts; but it does not alter the iterative, trial-and-error process of establishing the count in the Elliott
Wave. As Frost & Prechter state, one can use the market action to
confirm the wave count as well use the wave count to confirm the
market action.11 Plotting a Gann line from the suspected start of a
3rd wave is an academic exercise. The Gann line itself does nothing
to establish that the cycle has begun a 3rd wave; and only if price
finds support at a Gann line during a 3rd wave can one conclude that
the line is appropriate.
The Gann lines contribute to the evaluation of the cycle only during the latter stage of the 3rd wave and during the 4th and 5th waves.
Evidence of the end of the 3rd wave and the start of the 4th wave
correction comes from price breaking below the first Gann line of
the cycle. During the 5th wave, one repeats the trial-and-error process to create the second Gann line, using the slope of the first Gann
line as an aid in choosing the slope of the second. The movement of
price in between the first (now resistance) and second (support) Gann
lines during a 5th wave gives the analyst confidence in the 5th wave,
which the author has found to be more volatile than the well-channelled 3rd wave, thereby obscuring the wave count. Finally, at the
price and/or time target indicated by the intersection of the two Gann
lines (perhaps with the confirmation of a third line), the analyst can
reduce market exposure, both confident that the predictable bulk of
the profit has been achieved and wary of the much greater volatility
that tends to follow a Vodopich convergence.
A general caution must be added about the reliability of the Gann
lines in the way they indicate support and resistance. Price may overthrow (rise above) the Gann lines especially near the top of the cycle
due to the momentum built up through the 5th wave; both Frost &
Prechter12 and Vodopich13 have observed such throwover. Conversely, price may fall away after breaking below the third Gann line
in an impulse wave so that the third line plays no resistance role at
all. And especially in smaller impulse waves, one may not be able to
see a third Gann line. However, to the extent that Gann lines contribute to finding the correct wave count, they sensitize the analyst to
other market measures signalling a reversal.
Finally, the Supercycle Wave (V) target of 29,000 in 2012 must be
considered preliminary since it lacks the confirmation of the third
Gann line. As we near the top, however, analyzing component waves
with Vodopich's approach will help bring that Supercycle high in the
Dow into focus.
Original Addendum Chart

Cycle Extension After July 1997
Dow Jones Industrial Average (Weekly Bars)
As discussed previously, at the 8/7/97 intersection in Chart 3, the

Dow breaks below the 102% line, indicating the end of Wave iii
within v of the cycle that began in April 97. What remains is the
wave count for Waves iv, v, and beyond. The author prefers to count
iv at the 9/11/97 Dow low of 7581.08 and a truncated v at the 10/8/
97 high of 8184.70. And this count puts the period in the Original
Addendum Chart after the October 97 correction as an extension of
the present Minute Cycle.
Overall, the entire price action since October 97 creates an inelegant Elliott Wave, an expanding diagonal pattern. Frost & Prechter
consider the expanding diagonal invalid, but Vodopich disagrees,
describing it as a 100% reliable top formation.14
The chart shows the first Gann line of the extension starting at
the 1/12/98 low of Dow 7447.39, drawn with a slope of 51%/yr. The
argument for this slope is that since this extension is a component
wave of the Minute Cycle from 1994, its slope must be a multiple of
34%/yr., the slope of the Minute Cycle. Validation of that choice
comes from the summer 98 correction, which finds resistance along
that line, culminating in the wave 3 top of Dow 9367.84 on 7/20/98.
The author counts the 4th wave to the 10/8/98 low of 7467.75,
which is a truncated C-wave in the a-b-c correction from July. The
argument in favor of finding the low here rather than on 8/31/98 is
that the S&P 500 Composite Index made a new low on October 8 as
did various sub-indices (e.g., SOX), and the VIX high in early October exceeded the August/September high.
From here, the authors amended Vodopoch analysis fails in its
purpose, to highlight the best among alternative impulse wave counts.
For the 5th wave, the favored Gann line begins at the 10/28/98 low
of 8328.97, beginning the iii within the 5th with a slope of 102%/yr.
While this Gann line indicates well resistance and support, especially
from mid-December 98 to mid-January 99, the wave count produces
a short 3, only +12.6%, and so is likely to violate the rule that wave 3
is never shorter than 1 and 5.15 (Refer to Original Addendum Chart.)
A Revised Addendum Chart presents the 102% line and 204%
line drawn according to Vodopichs original rule, from the start of
the 1st wave rather than the start of the 3rd wave. The success of
these Gann lines in identifying the best wave count suggests there
ADDENDUM - (4/30/99)
This addendum covers the DJIA after the Vodopich convergence
in August 97 (see Chart 3). On a smaller degree, smaller by one
Elliott-Wave degree in fact, this period is like the years from 1966 to
1973 (see Chart 5). What emerges from analyzing these two periods
is that the price action up to a Vodopich convergence fits well into the
Elliott Wave hierarchy, but that after the intersection of the Gann lines,
price does not fit neatly into a single cycle that itself fits inside a larger
cycle. The deep retracements of a post-convergence period undercut
the search for a single impulse wave with inter-related Gann lines.
MTA JOURNAL
Spring-Summer 2001
25
Appendix 1
Gann Line Slopes of Various Tradables
may be a legitimate reason for varying the Gann-line start points. In

the Revised Addendum Chart, the 102% line begins at the start of
the extensions wave i within 5, at the 10/8/98 low. This Gann line
indicates a top to wave iii within 5 at Dow 9647.96 on 1/8/99, followed by a wave iv triangle. In this count, the 204% line is drawn
from Dow 9211.5 on 3/3/99. Here the author reverted to the
amended approach, starting the 204% line at the start of 3 within v
within 5. These Gann-lines indicate well resistance and support
through the price action to date.
Revised Addendum Chart
Cycle Extension After July 1997
Dow Jones Industrial Average (Weekly Bars)
Appendix 2
Prices, Dates & Fibonacci Ratios for T Bond Future Contract from
April '97 to January '98
While the purpose of this research is to advocate a single method

in order to enhance the predictive power of the Elliott Wave, the
experience with the 102% line suggests a flexible approach is
needed. In particular, when the second wave is shallow, it makes sense
to draw the Gann line from the start of the 1st wave (Vodopichs approach), and when the 2nd wave is deep, to draw the Gann line from
the start of the 3rd wave (the authors approach).
Both Addendum Charts also include the 8.5% line from 1942
and the 17% line from 1984, both of which are part of the August
97 Vodopich Convergence (see Table 2). Throughout the extension, the Dow has had difficulty overcoming the resistance indicated
by the 8.5% line in 1998, and later in the beginning of 1999. Further, the Dow failed to break above the 17% line in 1998; and as of
this writing, the Dow continues to find resistance at this line.
The combination of these Gann lines, especially the 8.5% line
and 17% line, suggests that Primary Wave ((3)) and its extension
are near their peak; and price crossing back below the 8.5% line
and the 17% line will contribute to an assessment of the beginning
of Primary Wave ((4)).
MTA JOURNAL
Spring-Summer 2001
26
Appendix 3
Prices, Dates & Fibonacci Ratios for Minor Cycle Wave 5
BIBLIOGRAPHY
Barrons, New York: Dow Jones & Co., Inc. 1998.

Harry S. Dent, Jr., The Roaring 2000s: Building the Wealth and
Life Style You Desire in The Greatest Boom in History, New York:
Simon & Schuster, 1998; Touchstone, 1999.
The Elliott Wave Theorist, Gainesville, GA: Elliot Wave International,
Inc., 1998.
John J. Murphy, Technical Analysis Of The Futures Markets: A
Comprehensive Guide To Trading Methods And Applications,
New York: New York Institute Of Finance, 1986.
Robert R. Prechter, Jr. & A. J. Frost, Elliott Wave Principle - Key To
Market Behavior, Gainesville, GA: New Classics Library, 1995.
Martin J. Pring, Technical Analysis Explained, New York: McGrawHill, Inc., 1991.
Don Vodopich, Trading For Profit With Precision Timing,
Greenville, SC: Traders Press, Inc., 1984.
BIOGRAPHY
This research, submitted to the MTA in May 1999, fulfilled
the authors Phase III requirement of the CMT Program. Mr.
Hulton is indebted to his CMT Mentor, Gurney Watson, for his
guidance and support.
Mr. Hulton is presently Director of Trader Services at the
Electronic Trading Group, L.L.C.
ENDNOTES
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Vodopich, p. 59.
Frost & Prechter, p. 25.
Ibid, p. 71.
Ibid, p. 80.
Ibid, p. 283.
Barrons, 6/29/98, p. 46 (Inter view with Mark Perkins).
Ibid, p. 282.
Dent, p. 294.
Pring, p. 255.
Ibid, p. 73.
Vodopich, p. 55.
Vodopich, p. 47.
MTA JOURNAL
Spring-Summer 2001
27
THE METAPHYSICAL IMPLICATIONS OF

THE ELLIOTT WAVE PRINCIPLE
Jordan E. Kotick, B.A (Hons), M.A., CMT
As articulated by Frost and Prechter in their work, The Elliott Wave

Principle, the Wave Principle is Elliotts discovery that crowd behavior
trends and reverses in recognizable patterns. Elliott named and illustrated thirteen patterns, or "waves" that recur in markets and are repetitive in form but not necessarily in time or amplitude. He further
described how these structures link together to form larger versions
of the same patterns and how those in turn become the building
blocks for patterns of the next larger size and so on. Regardless of
the size, the form remains constant.
With earth's first clay they did the last man knead,
And there of the last harvest sowed the seed.
And the first morning of creation wrote
What the last dawn of reckoning shall read.
Omar Khayym
INTRODUCTION
It strikes me that a philosophical discussion of the Elliott Wave Principle is
a worthwhile and relevant pursuit, especially since some of its most noted
practitioners, such as A. J. Frost and Robert Prechter, do not hesitate to discuss philosophical issues in their writing nor do they fail to quote various
philosophers in connection with their own advocations. I believe that Frost
was the first to specifically articulate the connection between philosophy and
the Wave Principle as evidenced by his observation that [i]t is possible to
read into stock market behavior a philosophical significance under the basic
tenets of the Elliott Wave Principle. 1
There is no shortage of philosophical issues that can be discussed in relation to the Wave Principle, but the limitations inherent in this paper force me
to zero in on a select few. As such, I have decided to examine determinism and
specifically whether it should be said from a philosophical point of view that
the Wave Principle is inherently deterministic. This consideration also seemed
to have occurred to Frost: It is an open question whether or not man is a
puppet on a string. In the short term he is not, but over the longer period he
may be2 and Prechter, the Wave Principle form shows that a collective system
is...deterministic.3
This paper is not about the persuasiveness of any particular form of determinism nor the validity of the Wave Principle. Instead, my intent is to investigate the compatibility, or lack thereof, between the two. Deciding whether the
Wave Principle is deterministic is a challenging task since it requires a metaphysical examination of a theory that by its nature, was not directly intended
to address metaphysical issues. There is an important difference between the
determinism of a particular theory and the more enveloping, less precise notion that the world is itself deterministic. This latter view embraces a much
bolder metaphysical view and while it can be supported, it requires more than
just the consideration of the determinism of a particular theory.
As is the case with any philosophical undertaking, formulating a precise
definition of the beginning precepts is a daunting, yet not insurmountable,
task. However, a discussion of the semantics of the determinism is not the
primary focus of this paper, and so, I will use determinism in a general philosophical way while admitting at the outset that there are various versions of
determinism that I will omit due to the limitations of this paper. For the purposes of this paper, I will examine scientific determinism, and show why I
believe that a case can be made that it is compatible with the Wave Principle.
Chart 1
The Wave Principle is the pattern of progress and regress in which

progress occurs in specific patterns of five waves and reaction occurs
in specific patterns of three waves or combinations thereof.
Progress ultimately takes the form of five waves of a specific structure. The three waves in the direction of the trend are labeled 1, 3, 5,
and are separated by two countertrend interruptions, which are labeled 2 and 4.
The essential form is five waves generating net movement in the
direction of the one larger trend followed by three waves generating
net movement against it, producing a three-steps-forward, two-stepsback form of net progress.
Leonardo Fibonacci da Pisa
Leonardo Fibonacci da Pisa was born between 1170 and 1180.
He was the son of a shipping clerk named Bonaccio (for writing purposes, Leonardo nicknamed himself Fibonacci, short for filius Bonacci
which means son of Bonacci).
Fibonacci wrote three major mathematical treatises; the Liber Abaci
(Book of the Abacus) in 1202, Practica Geometriae (The Practice of
Geometry) in 1220 and Liber Quadratorum (Book of Square Numbers)
in 1225. Of the three, Liber Abaci is his monumental work. Fibonacci
continued to expand his mathematical insights and later re-released
an updated version of Liber Abaci in 1228. While the stated purpose
of the book was to introduce Hindu-Arabic numerals to Europe and
explain their usage, it is within the pages of the Liber Abaci that the
famous sequence was introduced by Fibonacci.
THE ELLIOTT WAVE PRINCIPLE

Ralph Nelson Elliott
Ralph Nelson Elliott (1871-1948) developed a theory of stock
market behavior that he detailed for the public in a series of 12 articles written for Financial World magazine in 1939. In 1946, Elliott
wrote what he considered to be his definitive work Natures Law The
Secret of the Universe. The grandiose title reflected the confidence Elliott had in his theory which he believed not only encompassed the
action of the stock market averages but also much larger natural law
that he believed governed all of mans activities.
MTA JOURNAL
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28
Leonardo Fibonacci discovered (or more accurately rediscovered)

what is now commonly referred to as the Fibonacci sequence of numbers: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 .... It begins with the number 1,
and each new term from there is the sum of the previous two. The
ratio of any two consecutive numbers in the sequence approximates
1.618, or its inverse, .618 after the first several numbers. The higher
the numbers, the closer to .618 and 1.618 are the ratios between the
numbers. The number .618034..., is an irrational number that has
been referred to historically as the "golden mean," but in this century as phi (f).
Elliott unified his theory in 1940 when he recognized that the
Fibonacci sequence was the mathematical basis for the Wave Principle. The Fibonacci sequence and its corresponding ratios govern
both the numbers of waves in a completed Elliott pattern and the
proportional relationships between the waves.
tory, the great course of human affairs, has not been the result
of voluntary efforts on the part of individuals or groups of individuals, much less chance; but has been subject to law.8
Cheney's view strikes me as consistent with the Wave Principle since
they both advocate that there is a definite pattern of development in
the apparently jumbled story of human history.9 Further, they both
argue that a system's general characteristics can be said to be determined, at least in part, by the structures and characteristics of the
constituents of those systems.
Every human event has a definite place in an unalterable and consistent structure of progress and regress as each society passes through
a defined series of antecedent changes in order to achieve a subsequent stage. Though individuals are agents that seem to bring about
the specific events of social history, they are simultaneously the instruments by which certain laws (Elliott waves) and mathematical
principles (Fibonacci) relating to the character of social action become manifest.
Both Cheney's view of history and the Wave Principle share the
common premise concerning the impotency of deliberate individual
actions to alter the course of social trends. Or as Voltaire poignantly
said in the passage on "Destiny" in his Philosophical Dictionary, "Everything is performed according to immutable laws...in spite of you."10
This line of thought argues that historical changes are the products of deep-lying forces which conform to fixed, although not always apparent, patterns of development in mass psychology. Didier
Sornette and Anders Johansen of the Niels Bohr Institute in Copenhagen provided evidence for the existence of a macro intelligence
when they wrote in 1997:
DETERMINISM
This metaphysical principle has been understood and assessed in
various ways over the centuries. Discussions concerning determinism are often challenging due to the concept involved: what "determinism" means. Since the 17th century, it has commonly been accepted as the doctrine/theory that all human thought, action or event
is caused entirely by preceding events. This is to say that all physical
events and human actions are determined by antecedent factors.
Philosophers distinguish between hard determinism (e.g. necessitarianism,4 fatalism5) and soft determinism (e.g. compatibilism6 , libertarianism7 ).
In addressing the validity of determinism, philosophers have often looked to science and scientific theory to represent the best guide
to the truth of determinism. Many philosophers have discussed determinism in light of opinions about metaphysical topics such as free
will or God. Historically, the principle of determinism applied to
both secular and theistic philosophers. While some thinkers, like
Immanuel Kant, discussed determinism in terms of the science of
the day, others made it part of their philosophy of nature.
Various writers have often referred to determinism, causality and
natural law as if they were synonymous. They are connected, despite
the fact that they are not fully equivalent and the differences between
them can be clarified if one wanted to make his/her analysis meticulous enough. For the purposes of this discussion, however, I do not
find it necessary to attempt to sharpen distinctions to the point of
emphasizing all the recognizable differences between the terms. Instead, I shall use them in an essentially common-sense fashion.
[T]he market as a whole can exhibit an "emergent behavior"

not shared by any of its constituent[s]. In other words, we
have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic
scale have no idea of.11
Determinism does not necessarily imply that each individual event
is causally determined. In spite of the fact that we apparently may
not insist upon causality for individual events, it seems that there is
some sort of regularity, since the apparently individual actions somehow build themselves into a regular pattern. What is behind this
regularity?
The regularity may be formally described by saying that there are
laws of behavior, such as the Wave Principle, although there are not
always laws for individual events. Elliott clearly believed that he discovered a law of nature. In his previously mentioned work, Nature's
Law, his first line reads: "No truth meets more general acceptance
than that the universe is ruled by law." He goes on to claim that "the
very character of law is order...it follows that all that happens will
repeat and can be predicted if we know the law."12
Frost shared Elliott's sentiments about law and order, as evidenced
by the following passages: "Law, or Order prevails everywhere and is
in and forms part of everything,"13 "Life is ruled by law and not by
accident,"14 and the "Universal law which asserts itself in our everyday affairs."15 Clearly, Elliott and many subsequent Elliotticans like
Frost believed in both laws of nature and the underlying order of the
universe.
The Wave Principle argues that human history illustrates a single,
transculturally invariant law of aggregate human mood and that law
is the Wave Principle. Is this law deterministic? It is the purpose of
the rest of this paper to find out.
MICRO OR MACRO
In the early 1930s, accomplished historian Edward Cheney studied various historical events in relation to the seemingly influential
actions of certain famous figures. After examining the ostensibly decisive effect exercised by individuals at the time and the role they
played in helping to bring about these historical events, Cheney concluded:
These great changes seem to have come about with a certain
inevitableness; there seems to have been an independent trend
of events, some inexorable necessity controlling the progress
of human affairs. Examined closely, weighed and measured
carefully, set in true perspective, the personal, the casual, the
individual influences in history sink in significance and great
cyclical forces loom up. Events come of themselves, so to speak;
that is, they come so consistently and unavoidably as to rule
out causes not only of physical phenomena but voluntary human action. So arises the conception of law in history. His-
MTA JOURNAL
Spring-Summer 2001
29
SCIENTIFIC DETERMINISM
SCIENTIFIC DETERMINISM AND THE WAVE PRINCIPLE

According to scientific determinism, in principle (though not always in practice), whatever happens can be accounted for by citing
natural laws and antecedent conditions. Elliott felt that he had formulated a law of nature according to which given events follow from
other things: "[e]ven though we may not understand the cause underlying a particular phenomenon, we can, by observation, predict
that phenomenon's recurrence." 17
There are traditional criticisms of determinism, specifically determinism in human affairs, based on the contention that human history does not exhibit the stability and the regular periodicity of science; therefore, historical events cannot possibly be elements of a
deterministic system. On this view, Newton provided a deterministic
system since he compiled in his mechanics a schema for mechanical
explanation of the physical world (for example, his 2nd law that force
on a body is equal to its mass times its acceleration). If one knew both
force and mass, one could calculate the acceleration. Thus in order
to find out the mechanical explanation of given phenomenon, one
had only to fill in the schema by finding the variables involved. If you
know the laws, and you know the present conditions, you can predict
the future.
This seems to be an unnecessarily narrow application of what a
deterministic system must be like. While this criticism may or may
not be persuasive to the idea of historical determinism before Elliott, the Wave Principle seems to provide a system that closely mirrors the mechanical explanations of many other sciences. If one knows
the current wave position, one can persuasively extrapolate the forthcoming patterns that are likely to unfold. He/she can deductively
reason, based on deterministic patterns, what the fractal structure
will look like and this forecasting will be based on the correct identification of the fractal pattern alongside the current position of the
pattern. Hence, I believe this should rebut those who might claim
that only "traditionally scientific" systems can be deterministic.
To understand the limited extent to which determinism is implied by the Wave Principle, it is important to understand the type of
fractal pattern it reflects. Traditionally, it has been assumed that
fractals are either self-identical (each component of the pattern is
exactly the same as the whole) or indefinite (self-similar to the extent that it is similarly irregular at all levels). Based on Elliott's discovery of a third type of self-similarity, Prechter introduced a new
type of fractal, a "robust fractal." This pattern has highly variable components that fall within a certain defined structure as Prechter notes:
"Component patterns do not simply display discontinuity similar to
that of larger patterns, but "[T]hey form, with a certain defined latitude, replicas of them." This "latitude" reflects nature's robustness
and variability within overall determined forms. While it may be an
open question whether every nuance of this "latitude" is determined,
the Wave Principle unquestionably rests on the premise that certain
essential aspects of the design always prevail.
Consider the following example: assume that you believe a wave
four has finished and that wave five is about to begin. Why should
this occur? According to Laplace, there are two ingredients in the
explanation:
A Brief History of Scientific Determinism

Ancient cultures often attributed reoccurring phenomena such
as natural disasters, disease and plague to various gods whose behavior they could neither predict nor comprehend. As time progressed,
people began to observe certain regularities in the behavior of nature. One of the first observations was the discovery of the uniform
path of heavenly bodies across the sky thus making astronomy the
first developed science. The mathematical foundation for this science was set more than 300 years ago by Newton. His theory of gravity is still used today to predict the motion of celestial bodies. From
this example of the birth of astronomy, other natural phenomena
were found to obey scientific laws. This led to the advent of scientific
determinism, which appears to have been first described by Pierre
Simon Laplace (1749-1827). In his Philosophical Essay on Probabilities
(1814), the French mathematician wrote:
We ought then to regard the present state of the universe as
the effect of its anterior state and as the cause for the one which
is to follow. Given for one instance an intelligence which could
comprehend all the forces by which nature is animated and
the respective situation of the beings who compose it an intelligence sufficiently vast to submit these ideas to analysis it
would embrace the same formula the movements of the greatest bodies of the universe and those of the lightest atom; for it,
nothing would be uncertain and the future, as the past, would
be present to its eyes.16
By "the forces that animate Nature," I take Laplace to mean the
"laws of nature." Laplace's claim is that if one knows the positions
and speeds of all the particles in the universe, one could, in principle, calculate their position and motion at any specific time in the
past or the future.
This view of determinism holds that the entire future course of
the universe has already been determined as a consequence of two
factors: natural laws and the state of the universe at any given moment of time. This is not to say that Laplace held that the course of
the universe was entirely knowable, since he did not believe that man
was capable of discovering or comprehending the totality of all the
natural laws that govern the universe. His claim was intended as an
explanation of the principles that govern our existence, not our ability to embrace such a vast understanding. Our inability to perform
the computations notwithstanding, the philosophical implications of
his view is that our behavior is determined by the laws of nature and
the state of the universe at any given moment.
German physicist Max Planck put forth the idea of quantum mechanics in 1900. Its implications for determinism were realized in
1926 by Werner Heisenberg, also a German physicist, through what
is now known as the Heisenberg Uncertainty Principle. This principle argues that one cannot measure both the exact position and
the exact speed of a particle. Laplace's vision was based on the necessary condition of knowing the exact positions and speeds of particles
in the universe at a given time, so it was seriously undermined by
Heisenberg's work.
Einstein was not satisfied with the apparent randomness in nature
and this led to his famous phrase "Der Herr Gott wrfelt nicht" ("God
does not play dice"). He seemed to have felt that uncertainty was
only temporary and that there was an underlying reality where particles had defined positions and speeds that would evolve as Laplace
had pointed out, according to deterministic laws.
MTA JOURNAL
1.
2.
3.
4.
Ingredient One: Natural Laws

Stock market prices trend and reverse in recognizable patterns.
The patterns are repetitive in form.
Progress takes the form of five waves of a specific structure.
Three of these waves, which are labeled 1,3,5, actually effect the
directional movement.
Spring-Summer 2001
30
5. Waves 1, 3, 5 are separated by two countertrend interruptions

which are labeled 2 and 4.
6. Wave 2 never moves beyond the start of wave 1.
7. Wave 3 is never the shortest wave.
8. Wave 4 never enters the price territory of wave 1.
Chart 2
Ingredient Two: Antecedent Conditions

Wave four has unfolded in three waves.
Wave a and wave c have traced out five completed waves.
Waves a and c are equal in length.
Wave four has not broken the price territory of wave 1.
Of course, this is not an exhaustive list of either the natural laws
involved in the Wave Principle nor of the potential antecedent conditions, but I believe the point is still made. In terms of the Wave
Principle, the Natural Laws and the antecedent conditions are beyond our control. The pattern of the markets is entirely determined
by the laws of nature and the antecedent condition. Natural laws,
such as the Wave Principle, account for the way the universe appears
to function.18 On this basis, scientific determinism is compatible with
the Wave Principle.
1.
2.
3.
4.
AUTONOMY AND FREE WILL

It would seem then that there is no room for collective free choice
or philosophically speaking, free will, in this macro-depiction of the
mechanics of the universe (the will is philosophically understood as
the faculty of choice and decision and figured prominently in the
writings of many philosophers such as nineteenth century thinkers
Schopenhauer and Nietzsche). Collective behavior (which is what
the Wave Principle represents) is determined by both the laws of nature and antecedent conditions. This does not explain specific acts
of individuals within the collective or therefore even the collective
itself, but instead general sorts of behavioral proclivities, personality
traits and the like. So while the individuals within the aggregate have
autonomy to choose, to the extent that they participate in the collective dynamic, their behavior is impulsive and therefore determined.
PREDICTION AND RETRODICTION

As argued above, while we cannot predict with any degree of certainty who, for example, the next Prime Minister of Canada will be,
we do have strong reasons for believing who it probably will be. While
our predictions about the future do not exclude all the conceivable
alternatives and leave only one possibility, they rule out a huge number of possibilities. This leads to the conclusion that even though
individuals who participate in the events of human history (such as
the election of the Canadian Prime Minister) have free choice in their
actions, their collective choice will fall within certain probabilities;
the "Wave Principle structurally restricts the number of possible outcomes of social trends."19 The ramification of this realization is that
not everything that is logically possible is necessarily historically possible at a given time in a given place. There are determining factors
for both what has happened and will happen throughout human history.
The Wave Principle specifies what the psychological make-up is
behind a bull or bear market, impulsive or corrective waves.20 If history can be understood (on a macro level) through its wave structure
and if the future is also predictable due to its unfolding wave structure, then, in principle, one can specify the circumstances under which
certain events will unfold such as when scientists, mathematicians
and artists are most likely to have creative success.
It is undeniable that humans are continual sources of novelties,
MTA JOURNAL
inventions and creation and that the emergence of these are not predictable. No one, for example, could have predicted Count Basie's
April in Paris or Darwin's Theory of Evolution. What the Wave Principle
can and does do, however, is ascribe the deterministic patterns that
allow for the favourable social conditions that are conducive to both
the undertaking of research and the acceptance of innovative discoveries and creations.
Whether specific events will take place is a question of probability
since the Wave Principle only dictates society's coming character
changes, but not necessarily specific events. This is to say that the
aggregate social mood fashions the character of history, not the specific manifestations.
Individual occurrences and events do not follow deductively from
the wave pattern. While the environment is certain and determined
by the wave pattern, the individual occurrences within that environment are based on probability.
Notice on Chart 3 that, for example, according to this particular
Wave count, after the Supercycle Wave 2 low in 1859, it was predict-
Spring-Summer 2001
31
only make the probable assertion that the pattern

will terminate at a certain point even though one
can be certain that the pattern will terminate.
Chart 3
CONCLUSION
During this paper, I have not attempted to defend either the validity of the Wave Principle nor
scientific determinism. My intention throughout
has been to determine whether the Wave Principle was compatible with this version of determinism.
I have drawn a number of conclusions from
this work. The Wave Principle seems to be consistent with scientific determinism. Aggregate
social mentation and the fundamental fractal pattern of the Wave Principle moves according to a
determined yet robust path that is based on natural laws and antecedent conditions. This is not to
say that one can identify determinism or the Wave
Principle with the potential to predict with unlimited accuracy. At the same time, however, they
are directed towards discovering regularities in
the operations of systems that will empower one
with the ability to formulate various rules that allow for the prediction or retrodiction of the occurrence of events.
I believe that based on the determined path of the Wave Principle, it is reasonable to say that we can predict the future behavior of
a large body of people but not the individuals that compose that body.
In other words, explanations of aggregate social mood based on wave
patterns have the structure of a straightforward deductive argument
while individual actions do not.
able (determined) that Supercycle Wave 3 would begin.21 It was also

predictable (determined) that the positive environment that characterizes a wave three (prosperity and optimism) would also occur. 22
Prechter used the social events and conditions of the past to retrodict
the position of the waves. This chart is one potential classification of
the cultural timeline of Western culture since Roman Times. While
neither the Industrial Revolution nor the plethora of events that
Prechter cites were determined, according to the Wave Principle, the
social-mood preconditions that helped give rise to these events were.
As Prechter has often noted, history repeats in mood, but not
necessarily in mode. Or, put another way,
EPILOGUE
Due to the inherent limitations of this paper, I have had to limit
the scope of my examination to specific areas. There remain, however, many other philosophical areas left to investigate.
As we move into the 21st century, technical analysis continues to
grow in reputation and stature, so much so that it is slowly being
accepted by mainstream academia. Hence, a philosophical look at
some of the techniques practiced and the beliefs held by technicians
is an area that I believe holds great potential. It is, in Shakespeare's
words, "undiscovered country." If we do indeed learn atop the shoulders of those who came before us, then I believe that some of
philosophy's greatest minds have valuable insights for us as technicians.
When I refer to the dearth in philosophical analysis of the financial markets, I am not referring to Wave Principle specifically (though
there is much more to say about philosophy and Elliott Wave) but
technical analysis in general. For example, the concept of the herd,
central to the technicians' view of market movement and market sentiment, was explored in detail by Nietzsche, Kierkegaard and
Heidegger. Aristotle had a lot to say about man as a "political animal"
and social creature. Thomas Hobbes' famous belief that a state of
nature was a state of war and that the life of man was "solitary...nasty,
brutish and short" certainly seems to ring true with not only the competitive, everyone-for-himself nature of trading, but also the typical
longevity of most traders. There is much we can and should learn
from these thinkers...one step backward, two steps forward.
In short, I believe there is a book waiting to be written. This is a
book that will look at the greatest philosophical minds and explore
Because fundamental Elliott wave patterns are limited in number... and because the continual expansion of degree imparts
uniqueness to every wave, interactive human mentation and
behavior, which produces history, are continually repeated, but
not precisely.23
I have one last point to make. Just as social-mood conditions are
determined but social events are not, the form of the impulsive and
corrective patterns are determined, but the dimensions of the waves
within the pattern are not. This leads to an important point regarding the nature the predictive power of Elliott waves. The general patterns of the Wave Principle are universal in form. But in reality, the
patterns are rarely, if ever, found asserted in precisely the same way
(for example, the length of fifth waves are not exactly the same in
every pattern even though they tend to gravitate towards predetermined Fibonacci projections), analogous to Einstein's famous expression that "so far as the laws of mathematics refer to reality, they are
not certain. And so far as they are certain, they do not refer to reality."
The consequence is that in applying the generalized patterns to a
specific occurrence, there will be some uncertainty concerning
whether the given situation adheres to the generalizations. The result of this is that aside from being unable to give the initial conditions that will result in an exact consequence (the termination of
wave five will end at .618 the net of wave 1-3 if and only if...) one can
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19
what they had to say about the state of nature, human thought and
our social condition and compare it to what we know and see in the
financial markets. As the layers of market analysis are peeled back
and examined, I have every confidence that one will find the footprints of history's greatest philosophers who, if listened to carefully,
have something important to tell us.
20
21
ENDNOTES
1
2
3
10
11
12
13
14
15
16
19
18
22
Robert R. Prechter, Jr., The Elliott Wave Writings of A.J. Frost and
Richard Russell, (Georgia: New Classics Library, 1998), p. 401.
Ibid., p. 398.
Robert R. Prechter, Jr., The Wave Principle of Human Social Behavior
and the New Science of Socionomics, (Georgia: New Classics Library,
1999), p. 414. Referred to as Socionomics for the remainder of
this paper.
Necessitarianism holds that humans do not have free will and that
actions are entirely determined by antecedent, external causes.
Philosophically, fatalism holds that the suffering and despair are
the inevitable fate of man. It is often used in conjunction with
determinism since it argues that every event is bound to happen
as it does not matter what we do about it. Like necessitarianism,
fatalism denies that human actions have any causal efficacy. A
determinist may believe that a hangover is the effect of a natural
cause, but the fatalist holds that a hangover will occur regardless
of whether one drinks or not.
Compatibilism acknowledges that all events, including human actions, have causes. But it allows for free actions when the actions
are caused by one's choices rather than external causes.
Metaphysically, the term libertarianism refers to the idea that human beings have free will and thus sees no inherent contradiction
between determinism and the proposition that human beings are
sometimes free agents.
Ernest Nagel, "Determinism In History," Philosophy and Phenomenological Research, Volume XX, September, 1959. p.291.
Socionomics is a field of study coined in Prechter's previously mentioned book, The Wave Principle of Human Social Behavior and the
New Science of Socionomics. It is the examination of social trends
based on the biologically based patterns of fluctuation in collective mood that are formological in that they have consistent Fibonacci-based mathematical properties and produce the Wave
Principle. Prechter argues that the patterning of social mood
guides and influences the character of individual and social behavior resulting in human actions that in turn cause the trends
and events of history.
M. De Voltaire, A Philosophical Dictionary, (London: C.H. Reynell,
1824), p. 385.
Prechter, Socionomics, p. 159.
Robert R. Prechter, Jr., R. N. Elliott's Masterworks, (Georgia: New
Classics Library, 1994), p. 216.
Prechter, Frost and Russell, p. 378.
Ibid., p. 398.
Ibid., p. 403.
Pierre Simon Marquis de Laplace. A Philosophical Essay on Probabilities, (New York: Dover Publications, Inc., 1951), p. 3.
Prechter, Masterworks, p. 216.
This is an epistemological claim, not an ontological one. I do not
believe there is any compelling reason to believe that if the Wave
Principle is true, it would communicate, as Galileo said, "the language in which the Book of Nature is written." Perhaps a language but not the language.
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Prechter, Socionomics, p. 414.

The charts on the right hand side of the page illustrate the psychological components and events indicative of impulse and corrective waves taken from A. J. Frost, Robert Prechter, Jr., Elliott
Wave Principle, (Georgia: New Classics Library, 1998). p. 77-80.
Chart on the following page taken from Prechter, Socionomics, p.
345.
Frost and Prechter, referring to the powerful and positive sentiments associated with third waves, called them "wonders to behold." Frost and Prechter, Elliott Wave Principle, p. 78.
Prechter, Socionomics, p.285.
BIBLIOGRAPHY
Bernstein, Peter L. Against the Gods, New York: John Wiley & Sons,
Inc., 1996.
De Voltaire, M. A Philosophical Dictionary, C.H. Reynell: London,
1824.
Dray, W. H. "Determinism in History." The Encyclopedia of Philosophy, Paul Edwards, editor. Volume 2, New York: MacMillan Publishing Co., and Inc. & the Free Press, 1967. Pp. 373-378
Frost, A.J. and Prechter Jr., Elliott Wave Principle. Georgia: New Classics Library, 1998.
Gies, Joseph and Frances, Leonard of Pisa and The New Mathematics
of the Middle Ages, Georgia: New Classics Library, 1969.
Hook, Sidney. Determinism and Freedom in the Age of Modern Science,
New York: New York University Press, 1958.
Marquis de Laplace, Pierre Simon. A Philosophical Essay on Probabilities. New York: Dover Publications, Inc. 1951.
McKeon, Richard. The Basic Works of Aristotle, New York: Random
House Inc., 1941.
Nagel, Ernest. "Determinism in History." Philosophy and Phenomenological Research, Marvin Farber, editor. Volume XX, New York:
University of Buffalo, 1959. Pp. 291-317.
Taylor, Richard. "Determinism." The Encyclopedia of Philosophy, Paul
Edwards, editor. Volume 2, New York: MacMillan Publishing Co.,
and Inc. & the Free Press, 1967. Pp 359-373.
Prechter Jr., Robert R. R. N. Elliott's Masterworks. Georgia: New
Classics Library, 1994.
Prechter Jr., Robert R. The Wave Principle of Human Social Behavior
and the New Science of Socionomics. Georgia: New Classics Library,
1999.
Prechter Jr., Robert R. The Elliott Wave Writings of A.J. Frost and
Richard Russell. Georgia: New Classics Library, 1996.
BIOGRAPHY
Jordan E. Kotick has an Honours Bachelor of Arts degree
with a double major in Economics and Philosophy, a Master of
Arts degree in Philosophy and is a Chartered Market Technician. Jordan was previously employed with CIBC World Markets
as a technical analyst and government bond trader. He is currently Senior Technical Analyst for Elliott Wave International
and Vice President of the Canadian Society of Technical Analysts. He can be reached at: jordank@elliottwave.net
Spring-Summer 2001
33

William K.N. Chan, CFA
Under this rule, the risk of being stopped out is highest when a
position is newly put on. Once it is in the money, the risk of being
stopped out is reduced.
The weakness of this stop-loss rule is that it becomes less effective
if positions are marked to market periodically, such that a big loss
could still show up on the monthly (or quarterly) valuations notwithstanding that the cumulative P/L since inception remains
positive.
2) Trailing stop-loss
Similar to the fixed % stop-loss, the trailing stop-loss rules require
investors to pre-specify a maximum loss limit, at which the position would be closed out.
The key difference from the fixed % stop-loss is that the stop-loss
trigger does not apply to the cumulative P&L. Instead, it applies
to the P&L relative to the highest profit achieved. Suppose a 2%
threshold is chosen: then the position would be stopped out once
the mark-to-market P&L drops more than 2% from its highest
point.
Therefore, this stop-loss rule not only seeks to protect capital but
also the profit accrued.
3) Other stop-loss rules
There are many other different kinds of stop-loss rules. These include:
I. Standard Deviation Stop-loss
Instead of defining the stop-loss in terms of a fixed % or dollar
amount, a standard deviation threshold can be used to achieve a
similar objective.
II. Price Level Stop-loss
The stop-loss trigger is set relative to the market price of the instrument traded rather than the P&L. The trigger is usually set at
a price level of technical significance, i.e. a support or resistance
level. This is very popular among short-term traders whose trading activities are driven primarily by technical analysis.
III.Event Driven Stop-loss
For instance, if a trade position is assumed based on the belief
that the central bank will intervene to support a certain level. The
absence of intervention after the breach of the level would trigger a stop-loss.
Each rule has its theoretical appeals, but for the purpose of this
study, we have only tested the fixed % stop-loss and the trailing stoploss rules, which are the most popular and widely used ones. As they
possess most of the basic and important characteristics of stop-loss
rules, the results should have a meaningful degree of general applicability.
INTRODUCTION
The objective of this paper is to study the efficacy of stop-loss mechanisms.
We have back-tested two of the most commonly applied stop-loss rules (fixed %
and trailing % stop-loss) on both a trend-following and a mean-reversion
trading strategy. The results from our tests indicate a significant negative
correlation between the value added by applying these stop-loss rules and the
profitability of the trading strategies tested. In other words, there was a tendency for these stop-loss mechanisms to undermine the performance of the profitable trading strategies and improve that of the unprofitable ones tested.
The results led us to question the expectation that stop-loss will enhance
trading performance over time by reducing the size of losses and argue that
investors should carefully examine (e.g. via back-testing) the impact of stoploss mechanisms on their trading strategies/style prior to adopting them.
In addition, we have discussed several important qualitative attributes of
stop-loss, which we believe should also be considered when assessing the desirability of using stop-loss. These include a reduction in the "risk of ruin,"
dilemma in re-entry and the impact of the "fear of regret" syndrome.
We conclude with a warning against a blind acceptance of the utility of
stop-loss, or even worse, an over-reliance on stop-loss. As indicated by our test
results, stop-loss influences primarily the "pattern" of loss rather than the
"probability" of loss. To most investors, it is the latter which matters. To effectively manage the "probability" of loss, investors should seek to control "risk,"
which is an ex-ante parameter, rather than "loss," which is an ex-post parameter. Risk-control requires a careful management of the size and nature of
exposures. Stop-loss, on its own, is not sufficient to achieve effective risk-control. An over-reliance on stop-loss may even generate a false sense of security,
with undesirable consequences.

Concept and Objectives of Stop-loss
Stop-loss refers to the practice of cutting position upon the breach
of a predefined maximum loss limit.
In applying stop-loss, investors usually have the following expectations/objectives in mind:
1) Risk control
Stop-loss is expected to minimize the "risk of ruin," which refers
to the cases whereby a major loss from one/two position(s) seriously undermines the capital base so that trading activities have
to stop.
2) Return enhancement
Stop-loss discipline forces traders to cut losing positions and ride
winning ones. It is expected to limit losses to small amounts, without constraining profit potential, resulting in an enhancement of
return over time.
The purpose of this study is to analyze the efficacy of stop-loss
mechanisms with respect to these objectives.
Back-Testing the Stop-Loss Mechanisms

The total number of tests conducted is 1,680, across different
markets and trading systems. This section provides a description of
the historical data used and the methodology applied. Though boring, these technical details are provided in order to put the test results into perspective.
1) Markets covered:
Equity indices of major stock markets and exchange rates of major currencies 1 against the US dollar are used in the back testing
exercise:
Types and Criteria of Stop-loss

In this paper, we focus primarily on two types of stop-loss rules:
1) Fixed % stop-loss
This is by far the most commonly used stop-loss rule.
Upon entering a trade, investors specify a maximum loss limit,
the breach of which would trigger a cut of the position.
The stop-loss trigger applies to the cumulative P&L since inception. It can be in the form of a % figure or in absolute dollar P&L
terms.
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Equity:
FX:
S&P 500
(USA)
FTSE100
(UK)
$-JPY
$-DEM
(Japanese Yen) (Deutschemark)
NIK225
(Japan)
DAX30
(Germany)
HSI33
(Hong Kong)
GBP-$
(Sterling)
$-CAD
(Canadian $)
AUD-$
(Aussie $)
It is most commonly used to generate return in a rangebound market whereby buy low sell high strategies pay off.
The formula of slow stochastics (%D) used is as follows:
%D = (%Kt, %Kt-1, ...., %Kt-m+1) / m where m = smoothing factor
%Kt = (C-L) / (H-L) x 100
where C = closing price at time t.
2) Time period tested:

Daily market close prices from Jan-1988 to Feb-1999 are used in
the back-testing exercise. The time period was chosen with an intention to incorporate the recent 10 complete calendar years of
history in the test. It should include enough diversity of market
conditions against which we seek to test the stop-loss mechanisms.
3) Stop-loss rules and parameters tested:
Both fixed % stop-loss and trailing stop-loss rules have been tested.
To simulate different level of risk tolerance, we have tested a wide
range of stop-loss thresholds, ranging from as tight as 1% to as
wide as 10%.
The full range tested of stop-loss thresholds tested is as follows:
1%, 2%, 3%, 4%, 5%, and 10%.
4) Trading styles / strategies tested:
Broadly speaking, all trading strategies can be categorized into
two main styles:
a) Trend-following = Momentum trades
Mean-Reversion = Contra-trend trades
Stop-loss rules are tested on both styles of trade.
5) Simulated trading rules:
The above two trading styles cannot be tested directly. For the
sake of back-testing, quantitative trading rules are used to simulate the two styles.
a) Trend-following trades
The trend-following trading style is simulated by Simple
Moving Average (MA) Systems, which combine a long dated
(slow) moving average with a short dated (fast) one to generate trading signals.
The formula used is as follows:
SMAt = (Pt, Pt-1, ...., Pt-n+1) / n
where t = reference date
L = lowest price during last n period

H = highest price during last n periods
Again, different parameter inputs are used to simulate traders/investors of different time-frame orientation. The full
range of parameters tested is as follows:
Observation period (n) for % K
n = observation period
SMA systems with different parameter inputs are used to

simulate traders/investors of different time-frame orientation
(short-dated versus long-dated). The full range of parameters
tested is as follows:
Long-dated SMA
Short-dated SMA
(250 days
;
50 days)
(250 days
;
25 days)
(100 days
;
50 days)
(100 days
;
25 days)
(25 days
;
10 days)
A buy (sell) signal is generated when the fast moving average crosses over the slow moving average from below (above).
The trading position will remain unchanged until either
an alternative trading signal is generated by the MA system or
a stop-loss is triggered.
Once stopped, will remain neutral until a new trading signal is generated.
b) Contra-trend / Mean-reversion trades
The mean-reversion trading style is simulated by the Slow
Stochastics indicator, which is an overbought/oversold indicator widely used by mean-reversion traders.
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Smoothing factor (m) for %D
(10 days
;
5 days)
(30 days
;
5 days)
(30 days
;
10 days)
(60 days
;
5 days)
(60 days
;
10 days)
(60 days
;
30 days)
(100 days
;
10 days)
(100 days
;
30 days)
(100 days
;
60 days)
A buy signal is generated when the value of the stochastics
indicator drops below the predefined oversold threshold, and
vice versa.
In the test, we adopt the commonly used overbought and
oversold thresholds of 85% & 15% respectively.
Once stopped out of a position, a neutral position will be
maintained until a new signal is derived.
6) Defining the profitability of a trading system and the value added
by applying stop-loss:
a) A trading system/strategy is considered to be profitable if its
cumulative P&L, with NO stop-loss applied, is positive, and vice
versa.
b) Application of stop-loss is deemed to add value if it contributes positively to the cumulative P/L of the trading system,
and vice versa.
7) Frequency (probability) versus magnitude of the impact of stoploss:
In this study, we focus on the frequency/probability, rather than
the magnitude, of positive versus negative impacts of stop-loss. Owing to the diversity in the nature and characteristics of the markets tested, aggregating the magnitude of the P&L impacts is likely
to produce bias or unrepresentative results, in the sense that the
most volatile markets would dominate the test results. In order to
give the results from each market an equal weighting, we have
opted to focus on the frequency (i.e. % probability) rather than
the magnitude of impact.
SUMMARY OF RESULTS
Results of the test are shown in the appendix. Tables A to H summarize the results of individual tests. More important are tables 1a to
7b, which contain the key findings. These include:
1) The impact of stop-loss on the "pattern" versus the "probability"
of loss
The use of stop-loss changes the "pattern" of loss by reducing
the size of individual losses, but at the same time it increases the
frequency of losses. The net impact is uncertain and the overall
results are very mixed.
There is no significant conclusion we can draw from the crude
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2)
3)
4)
5)
results of individual tests2 which did not show any consistent impact of stop-loss on the final P&L.
However, a much clearer pattern emerges once we bisect the
test results according to the style and profitability of the trading
strategies tested (Tables 1a to 7b).
Impact of stop-loss on different trading styles (Tables 1a, 1b)
The application of stop-loss to trend-following trades generated mixed results. There is no significant evidence that it either
improves or undermines performance in a consistent manner (see
Table 1a).
The results from the application of stop-loss on mean-reversion trades are much more decisive. Stop-loss consistently improved
the performance of the mean-reversion trading strategies tested,
with a 73% probability. This result is consistent across different
markets, parameter values and stop-loss thresholds (see Table 1b).
Impact of stop-loss on profitable trading strategies (Tables 4a, 3a,
2a)
Stop-loss undermined the performance of the profitable trading systems with a 64% probability.
In only 31% of the cases, stop-loss further enhanced the results of the profitable trading strategies tested.
This observation applies to both mean-reversion and trendfollowing trading styles.
Impact of stop-loss on unprofitable trading strategies (Tables 4b,
3b, 2b)
Stop-loss improved the performance of unprofitable trading
strategies with a 73% probability.
In only 22% of the cases, stop-loss further exacerbated the loss
of unprofitable trading strategies.
This observation applies to both mean-reversion and trendfollowing trading styles. The results are very robust in both cases,
with a 84% and 62% probability of return improvement respectively.
Relative efficacy of trailing stop-loss versus fixed % stop-loss
(Tables 7a, 7b, 6a, 6b, 5a, 5b)
The results are not robust enough for us to draw conclusions
about the relative efficiency of the two types of stop-loss rules tested
(see Tables 7a & 7b).
However, there is a clear tendency for trailing stop-loss to outperform in the cases where the underlying trading strategies are
unprofitable and underperform in the cases where the underlying trading strategies are profitable. This can readily be seen by
comparing table 6a to 5a and table 6b to 5b.
set or even exceeded the savings from accurate stop-loss.

2) The results indicate a significant negative correlation between the
profitability of the underlying trading strategies tested and the
value added by applying the stop-loss mechanisms tested. This
serves as a warning against the blind acceptance of the utility of
stop-loss. Indeed, based on the results, an argument can be made
that if a stop-loss is found to work "consistently" with a trading
strategy, one should query/check the effectiveness of the trading
strategy itself. An investigation should be made to check if there
are any particular weaknesses or features in the trading strategy
which are responsible for the consistent profitability of the stoploss. Such weaknesses should be directly overhauled if possible
rather than controlled by stop-loss. In our test, for instance, the
application of the stop-loss mechanisms tested to the mean-reversion trading strategy tested, in equity markets, was found to be
consistently adding value. However, the fact is that the trading
strategies themselves were counter-productive in many cases (see
Tables C & D). All equity markets tested, with the exception of
Japan, have been in a steady uptrend over time. This did not favour
the application of the mean-reversion strategy tested. Application
of stop-loss, in such cases, improves the performance simply by
over-ruling the trading signals from the mean-reversion strategies,
which were consistently unprofitable. In cases similar to these, instead of seeking help from a stop-loss mechanism, it would make
more sense to seek to improve or alter the trading strategy itself.
3) Relative to fixed % stop-loss, trailing stop-loss tends to have a
greater impact on the trading P&L. Owing to its functional specification, trailing stop-loss are triggered more often (or timely) than
the fixed % rule, given the same % threshold. Thus, by its nature,
a trailing stop-loss is a "tighter" stop-loss than an equivalent fixed
% one. This explains our test results which showed a tendency for
the trailing stop-loss to outperform the fixed % one in those cases
whereby the underlying trading strategy was unprofitable and vice
versa.
So far, we have focused on the quantitative attributes of stop-loss
mechanisms. Their qualitative attributes are however no less significant and should be taken into account when one is considering
whether to apply a stop-loss. In the next section, we analyze the qualitative advantages and disadvantages of applying stop-loss.
QUALITATIVE ATTRIBUTES OF
STOP-LOSS MECHANISMS
Advantages of applying stop-losses
1) Reduce risk of ruin
The adoption of a stop-loss rule requires one to determine, in
advance, one's maximum "loss-tolerance" in a trade/position. In
this sense, the discipline of stop-loss will help to reduce the "risk
of ruin" regardless of its eventual net impact on the overall profit
and loss 3.
2) Avoid last minute decisions
Having a stop-loss discipline also helps to avoid the need to make
last minute decisions, which tend to be less well-thought out or
even irrational. When forced to make a last minute decision under pressure, investors are more likely to suffer from the "fear of
regret" syndrome. That is to say, having lost money in a position,
investors would hesitate to cut the position, fearing that the market price could reverse course, causing regret. Such "fear of regret" often works against one's investment process and discipline
and could significantly exacerbate the loss. A discipline in stoploss reduces the need to make last minute decisions and thus reduces the undesirable impact of "fear of regret."
INTERPRETING THE RESULTS

1) The results lend support to the argument that a stop-loss discipline is more important to those with a mean-reversion trading
style than those who are trend-followers. One key distinction between a mean-reversion and a trend-following trading system is
that the latter has an in-built mechanism to prompt a trader to get
out of a loss-making position, the latter does not. The trade signal
from the overbought/oversold (mean-reversion) trading system
would only grow stronger as the trend persists against the trader's
position. By contrast, a trend-following system would automatically prompt the trader to close out a loss-making position as the
trend reverses. In addition, stop-loss mechanisms tend to work
against the discipline of trend-following. Stop-loss can be triggered
by short term volatility (noise) despite an unchanged underlying
trend. The results of the test on trend-following strategies indicate neutral to negative impact from stop-loss. This reflects that
the impact of missing out significant medium term trend has off-
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Disadvantages of applying stop-loss

1) Dilemma in re-entry
This is especially problematic for trend-followers. Stop-loss could
be triggered by short term volatility, despite an unchanged underlying trend. Once stopped out, one has to face the dilemma of
whether to re-enter the trade. If one should decide not to re-enter the trade despite an unchanged trading signal from the investment process, the integrity of the investment process could be
undermined. If, however, one should opt to re-enter the trade,
the original objective of applying stop-loss would be defeated.
2) Ineffective risk control
Many investors have "risk-control" in mind when adopting the stoploss discipline. Unfortunately, stop-loss by itself is not an effective
tool in risk-control. Although stop-loss reduces the risk of a single
large loss, it can generate a series of small losses, which in total
can exceed the single loss. Our test results, for instance, suggest
that the stop-loss mechanisms tested influenced primarily the pattern rather than the probability of loss. To most investors, it is the
latter which matters. Without understanding this, an application
of stop-loss could generate a false sense of security, or even result
in a sub-optimal risk control. In fact, if one's prime objective is to
control the "probability" of loss, then, instead of seeking to control "LOSS," which is an ex post parameter, one should seek to
control "RISK," i.e. expected tracking error, which is an ex ante
parameter.
eralized conclusion on the desirability of stop-loss beyond what we

have commented on based on the results of our quantitative tests.
A common feature of the stop-loss mechanisms tested is that they
influenced primarily the pattern rather than the probability of loss.
To most investors, it is the latter which matters. Without understanding this, an application of stop-loss could generate a false sense of
security, or even result in a sub-optimal risk control.
ENDNOTES
1
Note that the choice of markets to be tested is arbitrary and reflects the background of the author who specializes in equity and
currency market investment. The markets included in the test represent over 80% of global equity markets in terms of market capitalization and over 90% of FX trades in the global currency market on an average day. The test is readily replicable for investors
specializing in bond or commodity market investment.
Crude results are not shown in the appendix because the number
of data points are very large, and we are not drawing any conclusion based on the crude results. All our conclusions are based on
the summarized/bisected results shown on Tables A to H and table
1a to 7b.
For readers interested in the subject matter, the "Risk of Ruin"
article from Kaufman on Market Analysis, April 1994 provides a
insightful quantitative analysis.
BIBLIOGRAPHY
CONCLUSION
In this paper, we have studied, via both quantitative and qualitative analysis, the efficacy of stop-loss mechanisms. We have back-tested
two of the most commonly applied stop-loss rules (fixed % and trailing % stop-loss) on both trend-following and mean-reversion trading
strategies. The results from our tests indicate a significant negative
correlation between the value added by applying these stop-loss rules
and the profitability of the trading strategies tested. In other words,
there was a tendency for these stop-loss mechanisms to undermine
the performance of the profitable trading strategies tested and improve that of the unprofitable ones in the test. This observation is
true of both trend-following and mean-reversion trading strategies,
although the results are more robust statistically in the latter case.
The results lead us to query the expectation that stop-loss would
enhance trading performance over time by reducing the size of losses.
There are cases, certainly not a negligible minority as far as our test
results are concerned, whereby the tested stop-loss behaves in a fashion similar to an insurance policy, i.e. it generates a "loss" when the
underlying trading strategy works well, and vice versa. We therefore
argue against the blind acceptance of the utility of stop-loss mechanisms. It is advisable that investors should pre-examine (e.g. via backtesting) the impact of stop-loss mechanisms on their trading strategies/style before adopting them.
Besides, based on the test results, we also argue that a consistent
value added from stop-loss should not lead to complacency. Instead,
it should be taken as a warning signal that the trading strategy may
contain a particular weakness which is responsible for the consistent
profitability of the stop-losses. To the extent that is possible, such
underlying weakness should be overhauled directly rather than controlled by a stop-loss.
There are other advantages and disadvantages of applying stoploss which are not readily quantifiable. Namely, applying stop-loss
reduces the risk of ruin and avoids the need to make last minute
decisions. However, in applying stop-loss, investors would also suffer
from the difficult dilemma of re-entry. As each investor would attach
different importance to these qualities, it is difficult to draw any gen-
MTA JOURNAL
Perry J Kaufman, Kaufman on Market Analysis, "Risk of Ruin" April

1994 issue and "Stop-Losses," October 1993 issue.
Leopold A Hauser,"A Review of Three Risk Control Methods for
the Stock and Futures Markets", MTA Journal Issue 50.
BIOGRAPHY
William K.N. Chan is Head of FX Strategy in HSBC Asset Management Limited. Before taking up his current position in London, he was a member of the Tactical Investment Unit of the
same company responsible for technical analysis and FX decisions. He also produced quantitative analysis on other areas of
investment management. One of his research articles on portfolio rebalancing was published in the Pensions & Investment
magazine.
William holds a M.Sc. degree in Economics from the L.S.E.,
University of London and a BSSc. degree in Business Studies
and Economies from the University of Hong Kong. He has been
a CFA since 1997.
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APPENDIX I (TABLES A-H)
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APPENDIX II (TABLES 1A - 7B)
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INTERMARKET BREADTH INDICATORS:

Does the Price Action of Interest Rate Sensitive Stocks Provide Clues to
Trends in Bonds Prices?
Gary Stone, CMT
SUMMARY
entered into computer trading system to determine if the breadth of

interest-rate-sensitive stocks provides any information about the health
of the trend in interest rates (bond prices).
If markets are efficient, then they should be interrelated. As such, the price
action of interest rates should be correlated with that of interest-rate-sensitive
stocks. Additionally, the "breadth" of the indexes should describe the health of
the prevailing price trend in interest rates. First this study determines that of
several popular interest-rate-sensitive stock indexes, (Dow Jones Utility Average, S&P Electric Company Index, The Philadelphia Bank Stock and Utility
Indexes, The Morgan Stanley Cyclical Index, the S&P Line Insurance Index,
and the S&P Bank Stock Index) only the Dow Utility Average, the Philadelphia Utility Index and S&P Electric Company Index from July 1977 to April
1997 are significantly correlated with bond prices (as defined by 100 minus
the bond yield). The study then uses subjective charting techniques and nonsubjective computer trading systems with the rules from the Martin Zweig's
Zweig Indicator and Gerald Appel's STIX Indicator to illustrate that in fact
the breadth of movement in the S&P Electric Company Index contains some
valuable information (forward-looking) for determining the health of bond
market trends.
II. BREADTH: AN INTRODUCTION TO THE

ADVANCE-DECLINE LINE
Construction
The A-D line was developed in 1926 by Col. Leonard Ayers of the
Cleveland Trust Co. who was attempting to determine the location
of buying and selling climaxes of the Dow Jones Industrial Averages
(Merrill, 1988). The A-D line is simply a measure of demand, determining the degree to which the majority of stocks are participating
in the overall market trend. The theory of the A-D line is simple
"as long as the 'army' (breadth of the majority of stocks) stays in step
with the 'generals' (e.g. the New York Stock Exchange (NYSE) composite or any other market index), then the trend, by definition, is
healthy and should sustain. It's when the army shows signs of retreating, or not keeping pace with the generals, that (we become) concerned about the viability of the underlying trend." (Shaw, 1998)
When indexes make new highs and the majority of stocks are advancing, then internal trend is strong; there is widespread demand for
stocks and a greater possibility that more money will flow into the
market.
The two basic A-D indicators are constructed either by some ratio
of advances to declines (e.g. A/(A+D)) or a simple difference between the number of advancing and declining stocks (e.g. A-D). Since
the difference calculation can have extreme volatility, moving averages are usually employed as a smoothing device. However, if the
number of stocks in the underlying index changes over time, the
simple A-D calculation can be prone to biases making historical comparisons difficult. To compensate for this bias, some use A/(A+D+U)
as the A-D calculation. Table I shows an example of the simple difference calculation in practice.
I. INTRODUCTION TO THE STUDY

When investors fear a downturn in economic activity, they sell poor
quality stocks first (Pring 1991, p.286). Fewer and fewer issues begin
to participate in the stock market advance making the upward trend
vulnerable. Stock market breadth monitors the internal trend of the
market by tracking the difference between the number of advancing
and declining stocks. If markets are efficient in the sense that they
discount all available information in the price discovery process, then
they should be interrelated. As such, if we believe the proposition
that the internal trend of the stock market can forewarn stock market turnarounds, then "bad breadth" of interest-rate-sensitive stocks
should forewarn of a turnaround in interest rates (bond prices).
Generally, analysts look to the bond market for changes in interest rate trends that could influence the equity market. A secondary
consideration of this study is to determine if the price action of interest-rate-sensitive stock indexes provide advance signals of changes in
interest rates. This question is raised because of the disproportionate influence a few institutions have in the bond market. If more
participants mean more price action and more information in the
price discovery process, then interest-rate-sensitive stock indexes may
indeed lead bonds. Credit Suisse First Boston Corporation in a 1999
study also questioned bond market efficiency: "With their wide base
of participants and huge liquidity, equity markets resemble piranhas,
reacting rapidly to news. A few hundred institutions, moreover, dominate global credit markets, of which the top hundred have disproportionately large influence. In the U.S. Equity Market, by contrast,
individuals accounts for more than two-fifths of transactions, and the
proportion is rising due to cheaper trading costs."
This study is broken down into three parts to probe these questions: first is a discussion of breadth indicators, the study of the advance-decline (A-D) line including a summary of other analysts' research and work. Second, it is determined through correlation analysis if indexes popularly believed to be sensitive to changes in interest
rates are in fact correlated with bond prices. Third, the A-D body of
work is applied through a combination of chart analysis and rules
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Table I
Number of
Declining
stocks
Difference
(A-D)
Day
Number of
Advancing
stocks
A-D line
(Cumulative
running total)
200
300
-100
-100
400
100
300
200
300
200
100
300
450
50
400
700
100
400
-300
400
The ratio or simple difference calculation by itself acts as an oscillator with overbought and oversold levels. Like Col. Ayers, analysts
attempt to identify the extremes as an indication of buying climaxes
or selling capitulation. Contrarians generally use such evidence as a
signal that the market has exhausted itself and initiate counter-trend
trades.
All of the indicators and research presented in this section were
developed for use in the stock market. These indicators use NYSE
composite or other composite data in their development and application. Simple A-D indicators include:
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41
Haurlan Index an exponential moving average of the simple

difference between advances and declines (A-D). With New York
Stock Exchange (NYSE) data, a short-term (3-day) exponential
moving average gives a buy signal if it's in excess of 100 and a sell
signal if it falls below 150. Analysts use the trend of a long-term
(200-day) moving average to generate signals.
Fosback an activity index because market direction isn't important. Defined as the absolute value of advances less declines (|AD|), high readings warn of a change in trend, while low values
indicate a continuation of trend. Using NYSE data, a cumulative
(25-day) running total of the daily readings in excess of 11,000 is
bullish for the short-to-intermediate term (one month to one year).
The McClellan Oscillator based upon the simple (A-D) calculation and is one of the most popular indicators in stock market
A-D line analysis. It is a short- to intermediate-term breadth indicator based upon the same concept as Gerald Appel's Moving Average Convergence-Divergence Oscillator (MACD). Essentially it
is the difference between a 19-period and 39-period exponential
moving average of advances less declines (A-D). Typically, the
McClellan Oscillator reaches an oversold or overbought extreme
prior to a change in the trend of the stock market. An oversold
market is identified by oscillator readings between -70 and -100.
Oscillator readings of +70 to +100 indicate an overbought market.
Ratio indicators modify the calculation into some sort of ratio of
advances to declines. Ratios make historical comparisons appropriate because the ratio calculation transforms the indicator into a measure of extent, force or market conviction of the movement of the
stocks advancing (Merrill, 1998). Ratio indicators include:
Nicoski's A/D the A-D line is defined as the cumulative 30-day
moving average of the ratio of advances to declines (A/D). This
ratio determines the force of the advance in terms of the strength
of the decline, presenting the "classic struggle of bulls and bears"
(Dworkin, 1990). Nicoski's A/D oscillator generates a buy signal
if it crosses above 1.0 if it had been below 0.84 and a sell signal if
the oscillator crosses below 1.0 if it had been above 1.2. The oscillator also exhibits recurring cycles and patterns.
Martin Zweig's Breadth Indicator a 10-day moving average of
A/(A+D) and determines the strength of the advance in terms of
the issues that are being acted on. The indicator oscillates between 0 and 1. Oscillator readings are bullish above 0.66 and bearish below 0.367. A derivative of this indicator is the thrust. Zweig's
research determined that each of the last four bull markets since
1970 began with a thrust a significant rise in the indicator from
(0.40 to 0.615) within the last 10 trading days.
Gerald Appel's STIX Indicator similar to Zweig's (A/(A+D)),
except it is smoothed by a 21-day exponential moving average.
0.42 to 0.44 is oversold and 0.56 and 0.58 is overbought.
The Hughes Breadth Index a 10-day moving average of (A-D)/
(A+D+U) and is bullish above 0.25 and bearish below -0.22.
Fosback's Absolute Breadth Index a hybrid of the Hughes defined by |A-D|/(A+D+U) is bullish above 0.40 and bearish below
0.15.
The Merrill Advance Decline Divergence Oscillator (ADDO)
developed by Arthur Merrill. It employs the ratio (A-D)/U in
order to gauge the internal market conviction of advancing stocks.
This indicator attempts to remove the subjectivity of determining
divergences by calculating the difference between actual values
and forecast expected values obtained by using least squares
trendlines (statistical regression). Using the DJIA as an example,
Merrill would run the regression DJIAexpected = a + b*cumulative
running total of (A-D)/U. The ADDO is calculated from ADDO
= (100 * DJIA * (a + b*cumulative A/D volume)) 100. The
interpretation is that if ADDO is positive, the DJIA is pulling ahead
of the expected values, thus bearish (the generals are leading the
army). A negative value is bullish, since the expected values are
pulling ahead of the DJIA (the army is leading the generals). For
trading signals, Merrill uses a 2/3rds Standard Deviation above
and below the mean as extremes.
MTA JOURNAL
Line and Moving Average Interpretation

The A-D line is generally referred to as the cumulative running
total of either the ratio or simple difference of advances and declines.
This representation allows the line to have the attribute of having a
trend. A-D analysis generally contains three parts: comparison of the
cumulative A-D line trend with that of the overall market index; analysis of the A-D line's relative value to that of its moving average; momentum and oscillators.
A-D line trend analysis is simply a comparison the trend of the AD line with that of the overall market index. Both lines should move
in the same direction. This analysis is somewhat subjective, as is the
case with most traditional forms of chart pattern analysis. For the
most part, analysts attempt to identify divergence between the A-D
line and the index as an indication of a possible deteriorating health
in the trend. A rising A-D line with a declining index is considered a
bullish or "positive divergence" because the broader market is rising
even though the market index is declining (the army is leading the
generals). The converse is also true. A declining A-D line with a rising market index is considered bearish or a negative divergence because the broader market is not participating in the index advance
(the generals are leading the army). The analysis can be highly subjective, because depending upon an analyst's preexisting biases, the
same chart can be open to may different interpretations. (Dworkin,
1990).
For the most part, it is the trend of the A-D line that is important.
The level of the A-D line is only important to the extent that it confirms the new highs (or lows) in the index. A new high in an index
should be confirmed by a new high in the A-D line. Trend weakness
initially becomes apparent when the index soars to new highs (declines to new lows), but the A-D line struggles or fails to make a new
high (or fails to make a new low). Additional A-D line analysis includes the identification of traditional chart patterns contained in
the movement of the line: triangles, support and resistance zones,
can be used to identify breakout points, an indication that the broader
market is seeing demand (or selling pressure) that may not be apparent in the index. Moving averages and identification of reversal patterns on the A-D line can also be used to alert technicians of possible
changes in A-D line trend and ultimately in the underlying index.
Momentum and Oscillators
In an attempt to reduce the subjective interpretive nature of the
A-D line analysis, analysts have created oscillator indicators. Momentum indicators oscillate around 0 and are constructed similar to a
rate of change. For instance, a 12-day rate of change would be calculated by subtracting the value of the A-D line 12 days ago from the
level of the A-D line today (A-D t A-D t-12). Momentum can be
smoothed by taking a 10-day moving average of the rate of change.
Extreme values of the oscillator are considered to be warnings of
reversals. Although these momentum indicators try to remove the
subjective nature of A-D line analysis, research has shown that the
determination of "extreme" readings is also subjective and, moreover,
can change depending upon market conditions. The problem researchers point out is that the values of the momentum indicators
are relative analysts have to arbitrarily determine the extremes
(Downing, 1994). But these indicators are considered more robust
because the computer, using set rules, decides the turning points.
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III. INTEREST-RATE-SENSITIVE STOCKS AND

INTEREST RATE TRENDS
Methodology
As discussed, the A-D line is an effective tool because it captures
sector rotation. Investors sell weak stocks because they feel they are
vulnerable to an economic downturn. An extension of this theory
would logically be that if stock market participants believe that interest rates are going to rise, then they would sell stocks that are vulnerable to changes in interest rates.
Popular interest-rate-sensitive stock indexes are examined in this
study. First, a determination is made if these indexes are correlated
with interest rates. Then breadth indicators are constructed using
the price action of the stocks underlying the indexes. Using the traditional package of A-D line analysis (analysis of the line itself, moving averages, momentum and oscillators) the breadths of the interest rate stock indexes are tested to determine if they have any meaningful information concerning trends in interest rates. Daily data
from July 1979 to April 1997 were used in this study.
Correlation Analysis: Are Interest-Rate-Sensitive Stock

Indexes Correlated with Bond Prices?
Tables II and III show simple correlation matrixes on daily and
weekly time frames for each index with respect to the bond's discountprice from the official start of the index to April 1997. (Note that
despite the later "official start" date of the index, stocks underlying
the indexes have price history starting from July 1979 which makes
A-D line analysis from 1979-1997 possible.)
This analysis illustrates that the Philadelphia Utility Index and the
S&P Electric Company index are highly correlated not only with the
bond's discount-price, but also each other across all time frames tested.
The Dow Jones Utility Average is also correlated, but there were periods (1996, for example) when the correlation was not significant.
(This may be a result of the Dow Jones Utility Average containing
Natural Gas Companies, whereas the S&P Electric Company and Philadelphia Utility Indexes do not).
Interest Rates
Although there are several proxies for interest rates, the yield on
the U.S. Treasury 30-year bond is the most preferable for several reasons. Other possible proxies include The Dow Jones Bond Average
and the 30-year U.S. Treasury Bond futures contract traded at the
Chicago Board of Trade.
The Dow Jones Bond Average uses 20 bonds traded on the New
York Stock Exchange. The problem with this index is it contains
convertible bonds that can distort the actual movement of interest
rates. Companies subject to merger and acquisitions rumors that
have bonds with convertible options will respond to factors that have
nothing to do with interest rates, but perhaps the convertible options
being reevaluated. Additionally, changes in perceptions of credit
quality will affect this index even if expectations of interest rates don't
change.
The 30-year U.S. Treasury Bond futures contract traded at the
Chicago Board of Trade has two problems. The first problem is that
although it does trade off the underlying behavior of the actual 30year U.S. Treasury Bond, it is a futures contract, and thus by definition trades off a future expected outcome. The convergence doesn't
occur until the final month of the contract. The second problem is
the issue of the roll. The bond contract is a quarterly contract. Each
quarter, gaps in price occur due to one contract rolling off and another starting. These gaps are more pronounced than the "rolls" that
occur from the Treasury auctioning other bonds.
The proxy we have selected is the yield of the current U.S. Treasury 30-Year Bond. This probably is the most accurate proxy for interest rates because most analysts tend to look at the bond for trend
changes that could forewarn of changes in the equity market. Since
classical chart analysis is based upon price movement, the Treasury
Bond yield is converted into a "discount" price, 100-yield (yield and
price move in opposite directions).
Chart I
Philadelphia Utility Index and the Bond
Bond is the "Discount" price defined as

(100 - 30 year U.S. Treasury Bond yield)
Surprisingly, the banks, cyclicals and life insurance indexes were

not correlated with movements in the bond discount-price, but were
highly correlated with each other. The correlation between the S&P
Bank Index and the Philadelphia Bank Stock Index is not altogether
surprising since they contain many of the same stocks (see appendix
I for more detail), but the strong correlation between the banks, life
insurance companies and the cyclical stocks is extremely interesting.
It means that they are reacting to the same influences, which are
widely believed to be interest rates. Though not tested, one interpretation may be that these stocks are more correlated with short-term
interest rates (such as Treasury Bills or 2-Year Notes), which are directly influenced by perceptions of and actual moves in monetary
policy by the Federal Reserve than bond yields.
Interest-Rate-Sensitive Indexes
It is generally thought that utilities, banks, life insurance companies and cyclical stocks are greatly influenced by interest rates. As
such the following eight indexes were analyzed (see Appendix I for a
list of the stocks that compose each index):
The Dow Jones Utility Average, an average of 15 utility companies
listed on the New York Stock Exchange that are involved in the
production of electrical energy and natural gas;
The Philadelphia Utilities Index, a capitalization-weighted index
MTA JOURNAL
of 20 utility companies involved in the production of electrical

energy;
The S&P Electric Company Index, a capitalization-weighted index of all stocks designed to measure the performance of the electrical power utility sector;
The Philadelphia Bank Stock Index, a capitalization-weighted index of 24 national, money center and regional lending institutions;
The S&P Bank Stock index, a capitalization-weighted index of all
companies involved in the business of banking;
The Morgan Stanley Cyclical Index, a capitalization-weighted index of 30 stocks which are cyclical in nature;
The S&P Life Insurance Index, a capitalization-weighted index of
all life insurance companies.
Spring-Summer 2001
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Chart III
Dow Jones Utility Average and the Bond
Chart I confirms the results of the correlation matrix: the Philadelphia Utility Index and the bond discount-price tend to move in
tandem. Upon closer examination, however, it appears that the Philadelphia Utility Index tends to bottom and peak before the bond discount-price. Chart II shows the S&P Electric Company Index and
the bond discount-price. Again, the S&P Electric Company index also
appears to bottom and peak before interest rates. Chart III shows the
Dow Jones Utility Average and the bond discount-price. Although
both series tend to move in tandem, the Dow Jones Utility Average fit
is not as good as either the Philadelphia Utility or S&P Electric Company index as the correlation matrix suggests.
(right scale)
Bond is the "Discount" price

defined as (100 - 30 year U.S.
Treasury Bond yield)
Chart II
S&P Electric Index and the Bond
(left scale)
Bond is the "Discount" price defined as (100 - 30 year U.S. Treasury Bond yield)
(right scale)
Chart IV
Philadelphia Utility Index A/D and S&P Electric Company Index A/D
Weekly
(left scale)
A-D Analysis: Does Breadth Give Clues to Changes in Trends

of Bond Prices?
Both the correlation matrixes and the accompanying graphs suggest that the Philadelphia Utility and the S&P Electric Company indexes provide the best fit on a macro level. Therefore, these indexes
were used to see if the breadth of the indexes contains any forward
indications that a change in the trend of interest rates is about to
occur.
As noted earlier, the Philadelphia Utility and S&P Electric Company indexes are extremely correlated. This is not at all surprising
since the Philadelphia Index is an inclusive subset if the S&P Index.
The S&P Index includes nine more electric companies than the Philadelphia Index (see Appendix I).
Although the indexes are highly correlated across a variety of time
intervals, the interesting question then becomes, does the presence
of the nine extra companies have a material effect on the cumulative
A-D lines generated from the two indexes? Surprisingly, the answer
is yes, but only recently.
Chart V
Philadelphia Utility Index A/D and S&P Electric Company Index A/D
Daily
Correlation of the Philadelphia Utility and S&P Electric Co. Index's A-D lines
7/79 4/97
1/79-12/94
1/96-12/96
1/97-4/97
99.2%
99.7%
88.0%
78.0%
The Philadelphia Utility Index A-D line and S&P Electric A-D line
are significantly correlated from July 1979 to December 1994. The
relationship, however, diverges beginning in 1996 suggesting that the
price action in the nine companies included in the S&P Electric Company Index has a material effect on the A-D line and further examination is needed.
Charts IV and V further illustrate this point that although the A-D
lines generated from the two indexes are similar in nature, there are
some striking differences. The period from late 1996 to April 1997 is
one such period. The A-D line in the S&P Electric Company Index
appears to continue its steep descent, while the Philadelphia Utility
Index A-D line appears to be leveling off.
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Chart VIII
A-D Line and Moving Average Analysis

A-D line and moving average analysis can be somewhat subjective
because analysts preconceptions can bias the interpretation. Subsequent analysis is, therefore, made more robust by creating "trading
rules." Rules allow the computer use the A-D ratios and oscillators to
make trading decisions and determine if the rules (the A-D indicators) are profitable (profit or positive results are the only true measure of a good rule).
S&P Electric Company Index A-D Line
Chart VI
Chart IX
Chart VII
Chart X
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Chart XI
downtrend, descending through its 50- and 200-day moving averages

before bond prices reverse trend. The A-D line spike in early 1994
was a false signal. However, had it been followed, bond prices were
little changed by the time the A-D line declined sharply signaling
that bond prices probably had further to fall (which they ultimately
did). At the late 1995 (area B) bottom, the A-D line completes a double
bottom, rises above its 50- and 200-day moving averages and is clearly
in an uptrend before bond prices recover. In mid-1996 (area C), bond
prices continue to trade higher, even though the A-D line is in a downward. Bond prices finally trade lower. It is not completely clear, however, that the A-D line rises above its 50- and 200-day moving averages
before bond prices. At a minimum, the A-D line confirms the recovery in bond prices, and at a maximum, the A-D line leads the bottom
in bond prices by crossing above its moving averages before bond
prices start to rise. The A-D line fails to signal lower bond prices in
early 1996 (area D). It is clear that bonds are in a steep decline before the A-D line begins its descent. But once the A-D line catches
up, it is interesting that the A-D line and bond prices appear to be
tracing out the same "flag" formations as bond prices continue to
descend.
Charts VI to XI show the S&P Electric Company Index A-D line

and the bond discount-price. Charts VI and VII show the A-D line
from late 1981 to 1984. The A-D line appears to reveal little about the
trend in interest rates. In fact, from running a correlation from 1979
to 1985 on the Dow Jones Utility Average (the only series which "officially" has data during those dates), bond prices had only a 35.2%
correlation. Thus, it is not surprising that A-D line doesn't provide
any information. From 1985 to 1990, the A-D line becomes more behaved, but again not very useful, except for the 1987 top. Chart VIII.
In 1987 the A-D line crosses down through its 50 and 200 day moving
average, officially denoting a downward trend while bond prices continued to consolidate (area A).
The correlations presented in Tables II and III illustrate that from
1990 to 1997, bond prices and interest-rate-sensitive stocks are correlated. The charts show that the indexes appear to lead changes in
bond prices. It also appears that the A-D line leads most trend changes
in bond prices. In Chart VIII (1991 to 1993), there are four significant turning points in bond prices. The A-D line appears to signal
that the trend in bond prices is subject to reversal before prices actually reverse.
In late 1990 (Chart IX, area A), the A-D line begins its trend reversal slightly before bond prices begin to recover. The A-D line creates
a double bottom and crosses above its 50 and 200 day moving averages, confirming the move in bond prices. In early 1991 (area B),
bond prices appear to trace out a head and shoulders reversal formation. When bond prices are peaking at the head, the A-D line does
not confirm the advance by both failing to make a new and appearing to move in the opposite direction as bond prices. The A-D line
appears to bearishly diverge before bond prices fall out of the head
and shoulders formation. The A-D line recovers before bond prices,
positively diverging. Throughout the rest of 1991, the A-D line confirms the upward trend in bond prices. The A-D line, however, creates a classic divergence from bond prices in early 1992 (area C):
bond prices continue their upward trend while the A-D line abruptly
reverses trend. The A-D line also appears to lead at the bottom of
the correction in mid-1992 as well. At the bottom of the mid-1992
correction, the A-D line is making a new high as bonds are making a
new low. At the top in late 1992 (area D), the A-D line clearly is in a
downtrend while the bond is completing a head and shoulders top
formation.
In Chart X, (late-1993 to early 1996), there are four significant
changes in trend. The first occurs in late 1994, as bond prices continue to make new highs although the A-D line is diverging in a
MTA JOURNAL
Philadelphia Utility Index A-D Line

The Philadelphia Utility Index is analyzed from 1996-97 because
both the Philadelphia Utility and S&P Electric Company A-D lines
were highly correlated with each other until 1996. Chart XI illustrates
what the correlations show statistically: that the S&P Electric Company Index and Philadelphia Utility Index A-D lines were similar until
1996, and then they diverged. Something was occurring in the extra
nine stocks in the S&P Electric Company Index that caused a shift.
Chart XI shows the bond discount-price and the A-D lines generated
from the Philadelphia and S&P index. In the beginning of 1996, the
S&P Electric Company Index A-D line didn't create any divergences
pattern which would have helped identify the intermediate bottom
in July 1996 (area A). The Philadelphia Utility Index A-D also failed
to diverge at that bottom. Both A-D lines, however, created bearish
divergences, peaking before bond prices in the late 1996, early 1997
intermediate top in bond prices (area B). In February 1997, the S&P
Electric Company Index A-D line diverged again, portending to the
correction in bond prices (area C). However, when the A-D line failed
to make a new high when bond prices did, then started to decline, it
showed that that the price rise in bonds was merely a correction.
Similar patterns occurred with the Philadelphia Utility Index A-D
line, but the action in the S&P Electric Company Index A-D line was
more dramatic and created clearer signals.
The seven extra stocks in the S&P Electric Company Index appear to have a material effect on the A-D line behavior. The S&P
Electric Company Index A-D line appears to be the better indicator,
and thus will be the one used in the trading system analysis.
Ratios, Oscillators and Trading Systems
Using the S&P Electric Company Index A-D data, computer trading systems were constructed using the Zweig, STIX and McClellan
Oscillator rules. The computer trading systems generate a more robust analysis because the rules are concrete and the computer employs the rules in a non-subjective manner. Since the majority of NYSE
stocks are believed to be interest-rate-sensitive, the rules used by the
system for the S&P Electric Company Index A-D are the same ones
employed for the NYSE A-D analysis. The buy and sell thresholds of
the oscillators are not optimized. Table IV summarizes the results.
Zweig
The Zweig rules are based upon the Zweig Breadth Indicator, a
10-day moving average of the ratio A/(A+D). The Zweig Breadth
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Spring-Summer 2001
47
CONCLUSIONS
indicator measures the strength of the advance in terms of the issues

that actually have supply and demand pressure. Oscillating between
0 and 1, Zweig's research determined when using NYSE stock data
that the oscillator is bullish when above 0.66 and bearish below 0.367.
The analysis on the S&P Electric Company Index Zweig A-D ratio
is quite interesting. With the exception of 1994-95 period, over 50
percent of the trades were winning and had positive net profit and
return on account. For the most part, however, this system encounters a few problems that would not make it a very good system to
blindly follow.
The largest winning trade for the most part is less than the largest
losing trade; the system does not cut losses short. In fact, intraday
drawdowns are quite large, making managing the account somewhat
expensive. By design the system always has a position in the market
(long or short). It appears that many of the problems the system
encountered were when it was short. The long trades had the greatest success. The short trades on average were losers, making the system appear to be unbalanced. Although on average the system was
successful, the results from 1994-1995 were not significant. It is very
interesting to note that the Zweig system was profitable, despite the
A-D line's inability to show any clear signals from 1979-1990. On
balance, the Zweig system is a good confirming indicator, but it doesn't
seem prudent to rely on it signals exclusively.
It appears that the price action of interest-rate-sensitive stocks provide clues to trend changes in interest rates, as defined by the bond
discount-price (100-bond yield). The S&P Electric Company and
Philadelphia Utility Indexes are significantly correlated with bond
prices. Under subjective chart analysis, the indexes appear to lead
bond prices at turning points. Further analysis showed that the S&P
Electric Company Index held a stronger correlation to bond prices
across various periods and subsequently was used for the rest of the
analysis.
Using subjective chart analysis, an A-D line generated from the
price action of stocks in the S&P Electric Company index appears to
contain some information concerning the viability of bond price
trends from 1990-97. Although chart analysis on the A-D line prior to
1990 suggests that there is correlation between bond prices and the
indexes, analysis using a set of rules applied to a computer trading
system disputes that finding. The fact that the computer finds that
there exists some information that the subjective chart analysis didn't
find highlights the problem with the A-D line chart analysis: it can be
quite subjective both biased by analysts' preconceptions and inability to spot information based upon the presentation of the chart.
The computer, employing rules in a non-subjective manner, buys
or sells bonds depending upon the S&P Electric Company A-D ratio.
The Zweig Breadth and STIX indicators both contain significant information about trends in bond prices. The Zweig Breadth Indicator was not successful across all time periods tested and the large
intra-day drawdowns and inability to cut losses short makes the indicator/system a poor trading system to use. The Zweig indicator can
be use used as short-term indicator, but confirming indicators should
also be employed prior to trading off the signals. The STIX indicator, however, offered significant results across all time periods indicating it would be an excellent intermediate-term indicator for trend
changes in bond prices.
STIX
The STIX indicator is similar to the Zweig Breadth Indicator, except it employs a longer (21-day) exponential moving average. Gerald
Appel, the creator of the indicator, identifies 0.42 and 0.44 as oversold and 0.56 to 0.58 as overbought for NYSE composite stock data.
Across all time frames, the STIX system using the S&P Electric
Company A-D data for signals to buy and sell bonds is profitable.
With the exception of the 1994-95 period, over 50 percent of the
trades in each time period were profitable, generating a significant
net profit and return on equity. Although during the 1994-95 period, less than 50 percent of the trades were profitable, the system
was able to cut the losses short, so net profit for the period was positive. Again the computer is always in the market (long or short), but
the difference with the STIX rules is that both long and short trades
are profitable. The system was also profitable during the 1979-1990
time period, the same period where the subjective analysis deemed
the A-D line and trends in interest rates to be uncorrelated. The STIX
system appears to be a more balanced system. Thus the S&P Electric
Company Index A-D using the STIX rules is a good intermediateterm indicator for bond trends.
REFERENCES
McClellan Oscillator
The McClellan Oscillator is a short- to intermediate-term breadth
indicator based upon the same concept as Gerald Appel's Moving
Average Convergence-Divergence Oscillator (MACD). Essentially it
is the difference between a 19-period and 39-period exponential
moving average of advances less declines (A-D). Typically, the
McClellan Oscillator reaches an oversold or overbought extreme prior
to a change in the trend of the stock market. An oversold market is
identified by oscillator readings between -70 and -100. Oscillator readings of +70 to +100 indicate an overbought market.
It was extremely surprising that the McClellan Oscillator did not
return any profitable results over the same time periods tested for
the Zweig and STIX indicators. Even when run through an optimizer,
the Oscillator was unable to return significant results.
MTA JOURNAL
Burke, Mike (1990). "The Advance/Decline Line" Technical Analysis

of Stocks and Commodities, July.
Chande, Tushar ( 1984). "Breadth, STIX and Other Tricks" Technical Analysis of Stocks and Commodities, May.
Colby, R.W. and T.A. Meyers (1988). The Encyclopedia of Technical Market Indicators, Dow Jones-Irwin.
Credit Suisse First Boston Corporation (1999). "Pythons and Piranhas" The Global Credit Strategist, July 7.
Downing, Daniel (1994). "Advance Decline Line Basics" Technical
Analysis of Stocks and Commodities, March.
Dworkin, Fay H. (1990). "Defining Advance/Decline Indicators"
Technical Analysis of Stocks and Commodities, July.
Hartle, Thom (1989). "An Advance/Decline Line for Commodities" Technical Analysis of Stocks and Commodities, May.
Merrill, Arthur ( 1988). "Advance Decline Divergence Oscillator"
Technical Analysis of Stocks and Commodities, September.
Meyers, Dennis (1996). "The Electric Utility Bond Market Indicator" Technical Analysis of Stocks and Commodities, January.
Mogey Richard (1989). "The McClellan Oscillator" Technical Analysis of Stocks and Commodities, September.
Murphy, John J. (1982). "The Link Between Bonds and Commodities" Technical Analysis of Stocks and Commodities, May.
Spring-Summer 2001
48
Murphy, John J. (1982). "The Link Between Bonds and Stocks"

Technical Analysis of Stocks and Commodities, June.
Murphy, John J. (1982). "Utilities and Bonds" Technical Analysis of
Stocks and Commodities, August.
Murphy, John J. (1986). Technical Analysis of the Futures Market,
New York Institute of Finance.
Murphy, John J. (1991). Intermarket Technical Analysis, John Wiley
& Sons.
Pring, Martin J. (1991). Technical Analysis Explained, McGrawHill Book Co.
Shaw, Alan R. (1988). "Technical Analysis" Financial Analysts Handbook, Second Edition, Dow Jones-Irwin.
Waxenberg, Howard (1985). "Technical Analysis of NYSI/DJI" Technical Analysis of Stocks and Commodities, December.
Williams, Mason (1994). "Advance Decline Line Basics" Technical
Analysis of Stocks and Commodities, Januar y.
MTA JOURNAL
BIOGRAPHY
Gary Stone is a VP of Business and Content Development
and Director of Finance and Strategic Business Planning for
Multicast Media, a startup company building a broadband broadcast overlay to the Internet to deliver high-quality streaming
media to the desktop. Prior to Multicast Media, he spent seven
years as a trader at Paribas Corporation in the Fixed Income
Department on the financing, short-term arbitrage, and U.S.
Agency desks. Mr. Stone was also an assistant economist in the
Domestic Research Division and a trader/analyst in the OpenMarket Trading Division of the Federal Reserve Bank of New
York. Mr. Stone has an undergraduate degree in economics and
computer sciences:mathematics from the University of Rochester and received an MBA from the Stern School of Business at
New York University.
Spring-Summer 2001
49
WYCKOFF TESTS: NINE CLASSIC TESTS FOR ACCUMULATION;

NINE NEW TESTS FOR RE-ACCUMULATION
Henry O. (Hank) Pruden, Ph.D.
PREAMBLE
precisely what is wrong, you cannot tell which way it is going.

No diagnosis, no prognosis. No prognosis, no profit.
This experience has been the experience of so many traders so
many times that I can give this rule: In a narrow market, when
prices are not getting anywhere to speak of but move within a
narrow range, there is no sense in trying to anticipate what the
next big movement is going to be up or down. The thing to do
is to watch the market, read the tape to determine the limits of
the get-nowhere prices, and make up your mind that you will
not take an interest until the price breaks through the limit in
either direction. A speculator must concern himself with making money out of the market and not with insisting that the tape
must agree with him.
Therefore, the thing to determine is the speculative line of least
resistance at the moment of trading; and what he should wait
for is the moment when that line defines itself, because that is
his signal to get busy.
The Wyckoff Method is a school of thought in technical market

analysis that necessitates judgment. The analyst- trader acquires judgment through experience and through well-guided illustrations of
basic principles. Although the Wyckoff Method is not a mechanical
system per se, nevertheless high reward/low risk entry points can be
routinely and systematically judged with the aid of a checklist of Nine
Tests. Each test in the list of Nine Tests represents a Wyckoff Principle.
One purpose of this article is to demonstrate the Nine Classic
Buying Tests of the Wyckoff Method at work via a case study of the
stock of the San Francisco Company. Although the case name is disguised as the San Francisco Company (SF), it does represent an actual company in the energy sector. For the sake of economy, the
illustrations in this article feature the bull side of the market, they
can be inverted to illustrate the bear-side of the market.
The classic set of Nine Classic Buying Tests (and Nine Selling
Tests) was designed to diagnose significant reversal formations: the
Nine Classic Buying Tests define the emergence of a new bull trend
(See Side Bar #1). A new bull trend emerges out of a base that forms
after a significant price decline. (The Nine Selling Tests help define the onset of a bear trend out of top formation following a significant advance.) These nine classic tests of Wyckoff are logical, timetested, and reliable. However, the original set of nine tests was not
designed to include all of those very crucial consolidation periods
that occur during bull markets and bear markets.
Students of the Wyckoff Method refer to consolidations as re-accumulation or redistribution. There exists a void in the Wyckoff
Method with respect to tests to define the trends that emerge out of
consolidation formations. Thus, a second major purpose of this article is an attempt to fill a void in the Wyckoff Method by introducing
a new set of Nine Buying Tests for Re-accumulation. This new set
of Nine Buying Tests for Re-accumulation (See Side Bar #2) shall
be illustrated with the same San Francisco Company case study to
which will be applied Nine Classic Buying Tests mentioned in the
preceding paragraph.
The San Francisco Company (SF) case study used in this article
reflects an actual trade made by an expert in the Wyckoff Method.
This Wyckoff expert used the stock options listed on SF as his trading
vehicle. Vertical line (bar) charts and figure (point and figure) charts
of SF will be used to illustrate both sets of Nine Classic Buying Tests,
for accumulation and for re-accumulation.
As the reader approaches this case of Nine Classic Buying Tests,
he/she ought to keep in mind the following admonitions from the
Reminiscences of a Stock Operator (See Appendix):
The average ticker hound or, as they used to call him, tapeworm goes wrong, I suspect, as much from overspecialization
as from anything else. It means a highly expensive inelasticity.
After all, the game of speculation isnt all mathematics or set
rules, however rigid the main laws may be. Even in my tape
reading something enters that is more than mere arithmetic.
There is what I call the behavior of a stock, actions that enable
you to judge whether or not it is going to proceed in accordance
with the precedents that your observation has noted. If a stock
doesnt act right dont touch it; because, being unable to tell
MTA JOURNAL
THE NINE CLASSIC BUYING TESTS OF THE

WYCKOFF METHOD
Side Bar #1 lists the Nine Classic Buying Tests of the Wyckoff
Method. Chart # 1 exhibits a vertical chart of the SF Company; Chart
#2 shows a figure chart of SF. A guide to How to Make Price Projections Using a Figure Chart is attached as an Appendix to Wyckoff
Tests.
This case situation of SF involves a Wyckoff-oriented trader who
diagnosed trading opportunities in SF. While the general market
index is not shown here, these trading opportunities exhibited good
relative strength compared to the general market index. The Nine
Classic Buying Tests were passed at the conclusion of the base-building period and the trader elected to buy call options on SF and to
enter stop-loss orders (mental) just below prior supports in the trading range. Later, as periods of consolidation come to a halt, the trader
could roll his options forward to a later month and to a higher strike
price. At the end of the SF case, the option trader is in a position to
wrap up his campaign, take his profit, and go home.
The First Wyckoff buying test to be passed was Downside (price)
objective accomplished. This test was passed at point #4 on the figure chart, which is the $21 level for SF. The preceding top in SF
around point #3 built the cause for the decline, and at $21 the maximum effect of that cause was realized.
The Second Wyckoff buying test was passed at point #8 on the bar
chart, which was a secondary test that occurred on relatively light
volume and narrowing downside price movement compared to the
selling climax at point #4. At point #4 the relative increase in volume and the price closing at the high of the day signaled to our Wyckoff-oriented trader that a provisional selling climax might be at hand.
At point #4, demand was entering the market to absorb the supply of
stock being offered in the vicinity of the downside price objective (buying test one). At this juncture the trader should have covered any
outstanding short sales on SF at the open of the next day.
The successful secondary test at point #8 revealed that supply was
being exhausted for the moment and so the downtrend was stopped,
at least temporarily. It was now the job of the trader to sit patiently
on the sidelines until an accumulation base had been formed.
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Chart 1
Vertical Chart, Daily
San Francisco Company
Chart 2
Point & Figure
San Francisco Company
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Spring-Summer 2001
51
tures at which to enter a long position. (See January 2001 issue of

the Active Trader magazine). At point #16 on the charts, and even
more definitely at point #18, the trader in the SF case concluded that
a base had been formed, a cause had been built and a favorable reward-to-risk ratio was present. The count taken along the $22 line
of the figure chart from point #16 back to beyond point #4 generated a cause of 27 points for upside projections of $47-49, when that
count was added to the low of the trading range at $20 and to the
count line itself at $22. Moreover, the count along the $25 level at
point #18 sanctioned price projections as high as $57. As a result of
these analyses, the trader was justified in concluding that the Eighth
Test had been passed.
Entering a long position in SF at $25 (point #18) and setting a
protective stop-loss order just below support at $19 would create a
risk exposure of $6. The figure chart count along the 25 line equaled
31 points of upside potential. Thus, the estimated profit potential
exceeded the indicated risk by over three times, so Buying Test Nine
was also passed. A comparison of the SF chart to its relevant market
index (not shown) would have revealed that SF was comparatively
stronger than the market. Consequently, SF was favored as a candidate with superior upside prospects. (Buying Test Seven was passed.)
By the time SF had reached point, #18 all of the Nine Classic
Buying Tests had been passed. At point #1: the line-of-least-resistance had defined itself as upward trending and the trader could
have entered call option positions with favorable reward to risk parameters. At this stage the trader did purchase SF call options that
were at the money.
Side Bar #1
Wyckoff Buying Tests: Nine Classic Tests for Accumulation
Nine Buying Tests (applied to an average or a stock after a decline)*
Indication:
Determined From:
1) Downside price objective accomplished
Figure Chart
2) Preliminary support, selling climax, secondary test

3) Activity bullish (volume increases on rallies and
decreases on reactions)
Vertical and Figure
4) Downward stride broken (i.e., supply line penetrated)
Vertical or Figure
Vertical
5) Higher supports (daily low)
Vertical or Figure
6) Higher tops (daily high prices rising)
Vertical or Figure
7) Stock stronger than the market (i.e., stock more

responsive on rallies and more resistant to
reactions than the market index)
Vertical Chart
8) Base forming (horizontal price line)
Figure Chart
9) Estimated upside profit potential is at least three times

the loss if protective stop is hit
Figure Chart for

Profit Objective
Adapted with modifications from Jack K. Hutson, Editor, Charting the Market: The
Wyckoff Method (Technical Analysis, Inc., Seattle, Washington, 1986), page 87
Side Bar #2
New Wyckoff Buying Tests Modified for Re-accumulation
Nine Re-accumulation Tests:

1. Resistance Line Broken (Horizontal Line across the Top of The Trading Range)
2. Activity Bullish (e.g., volume expanding on rallies, shrinking on declines)
NINE NEW BUYING TESTS FOR RE-ACCUMULATION
3. Higher Lows (price)
In a quest for unity and economy, numerous principles of the

Wyckoff Method were distilled into Nine Classic Buying Tests and
Nine Selling Tests. As explained above, the nine buying tests were
originally designed to define trends coming out of major areas of
accumulation that followed significant price declines. In addition to
these major reversal formations at bottoms and tops, there also appear many important continuation patterns known by students of
Wyckoff as re-accumulation and redistribution. However, these
important consolidation patterns lack an appropriate set of Nine
Tests to define the resumption of the upward trend or downward
trend. Re-accumulation and redistribution areas simply lack a set of
buying tests /selling tests that are equivalent to the Classic Nine Tests
for major accumulation or major distribution. Unfortunately, the
original set of Wyckoff tests that were used to define departures from
bottoms or tops cannot be transferred easily nor applied en toto to
zones of re-accumulation or redistribution. Some tests, such as Preliminary Support and Selling Climax and Secondary Test simply do
not apply. The selling climax is good for signaling the onset of a bottom after a bear market decline. But re-accumulation zones start
after a price advance, and thus most often commence with a buying
climax. A straightforward modification of the climax rule to fit reaccumulations is made even more ambiguous by the fact that distribution after a bull market advance may likewise start with preliminary supply and a buying climax.
Similar limitations apply to other tests found in the original list of
nine. For instance, neither The fulfillment of downside (upside)
price objectives nor the breaking of downward (upward) sloping
price line are necessarily relevant for analyzing re-accumulation (redistribution). In their place it is suggested that we substitute other
Wyckoff rules that tell us more clearly that a correction has been
completed in time and price. These substitute measures are, for example, the interception by price of the upward sloping demand line
4. Higher Highs (price)

5. Favorable Relative Strength (equal to or stronger than the market)
6. Correction Completed in price and/or time (e.g., 1/2 retracement, support line reached)
7. Consolidation pattern formed (e.g., triangular formation)
8. Stepping Stone Count Confirming Count
9. 3-1 Reward to Risk Ratio
Buying Test Three requires judging the volume on the rising and
falling price waves in the trading range. A visual inspection reveals
that by point #16 on the SF chart, volume was expanding on the rallies and shrinking on the declines. By the time point #16 was reached
on the vertical chart, SF would have passed the test: Activity bullish. Turning once again to the figure chart discloses that in the
vicinity of point #10 the downward sloping supply line (dashed line
SS) was broken. Thus around point #10, the Fourth Buying Test was
passed. These four foregoing tests, although necessary, were not sufficient evidence of accumulation, so the trader had to remain patient
until all of the buying tests clearly revealed that a base had been
formed and that the evidence had accumulated to prove that the line
of least resistance was decidedly upward.
The next two Wyckoff Tests are crucial to the definition of an
upward line of least resistance. Buying Test Five is higher lows (higher
supports) and Buying Test Six is higher highs (higher tops). The
vertical line or bar chart of SF showed higher price lows along the
gradient of points #14, #16, and #18. In a parallel fashion, a series of
rising price peaks appeared at points #12, #13, #15, and #17. At points
#17 and #18, the trader-analyst could clearly declare that the higher
highs and higher lows had been reached, and, therefore, Wyckoff
Buying Tests Five and Six had been passed.
Points #15 and #16, and then again #17 and #18 on the charts,
may also be viewed as Jumps and Backups, hence legitimate junc-
MTA JOURNAL
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52
and/or the reaching of the 1/2 re-tracement level.*

It is suggested that in place of downward stride broken, the
relevant buying test for re-accumulation become the breaking of the
horizontal resistance line along the top of the trading range. That
horizontal resistance line serves to confine the sideways trend channel in much the same way as the downtrend slanting supply lines
confine a bearish trend channel. Moreover, when a wedge or triangular formation appears, the Wyckoff literature advises the student
to enter upon the significant price-and-volume breaking of the resistance (support) line.
The Stepping Stone Confirming Count measures the amount
of potential generated during a re-accumulation trading range. The
stepping stone confirming count deserves special consideration as
a re-accumulation test because it possesses an important Wyckoff timing principle. Thus the trader should be alert to the possible resumption of the upward trend when the figure chart has generated
enough re-accumulation potential or count to confirm the target
from the original base. In the case of SF, this means the trader should
be poised for a resumption of the upward trend when the count generated during a consolidation grows large enough to meet the price
objectives that equal the objectives generated during the original accumulation base. If along the $35 level, for instance, the up and
down price waves during a period of sideways consolidation reach a
point where the figure chart count measures 14 points, thereby projecting to $49, then the trader should become highly alert for the
possible resumption of the upward trend. Remember that the original base count along the $22 level (point #16) projected to a maximum of $49. If a consolidation projects to the same objectives, then
we say that it Confirms the original count taken along the base.
The stepping stone confirming count appears as Re-accumulation
Test Number Eight on Side Bar #2.
taken together revealed a lack of supply being pressed upon the market. Moreover, the interception of the rising support line C-C indicated that a sufficient correction in time and price had taken place
(Test Six). However, it was not until the subsequent surpassing of the
resistance along the $31 level on June 11, on wide upside price movement and expanded volume, that SF satisfied several other Re-accumulation Tests, such as Test Number One Resistance Line Broken
and Test Number Four, Higher High (price). Then at point #23, a
pullback to a Higher Low was executed (Test Three) and a count
of the Figure chart along the 31 level would have projected upward
to $37-39. However, this count was insufficient to confirm the earlier
price target projections of $47-49 taken along the $22 level. Hence,
Re-accumulation Test Number Eight was not passed. Moreover, a trade
taken at 31 also would have fallen short of the 3-1 reward-to-risk minimum because a stop would need to have been placed 3 points away at
28, and the re-accumulation count was only 8 points. Thus, Test Number Nine also failed. Presumably a pattern analyst could have labeled
the consolidation from #19 to #20 a pennant (Test Seven).
RE-ACCUMULATION TESTS PASSED

With two tests already failed our trader chose to pass up adding to
his position at the point #23 juncture on the charts. Shortly thereafter the SF stock shot up from point #23 to point #27 and underwent
a more prolonged correction. This complex correction would have
been a challenge to the pattern recognition skills of most Wyckoff
Analysts. Nonetheless, the Wyckoff expert who was operating in the
stock identified it as a large wedge or apex (often called a one-eyedJoe by Wyckoffians), which thus fulfilled Re-accumulation Test Number Seven. He took a count taken across the $35 level back to the
zone around point #22. That count indicated a re-accumulation that
was sizable enough to reach the $47-49 target that was first established at point #16, and in the process it flashed a Stepping Stone
Confirming Count (Re-accumulation buy signal Number Seven).
As price broke out of this wedge formation, it burst through the
(downward sloping) Resistance Line connecting points 27 and 30,
thereby triggering a passage of Re-accumulation Test Number One.
On balance, the volume tended to expand during the rallies and
shrink during the declines, while the SF stock was in the triangular
trading range (passage of Re-accumulation Test Number Two). Price
registered a series of higher lows from point #23 to point #28 to point
#31 (passed Re-accumulation Test Number Three). These series of
higher lows by SF contrasted sharply with series of lower lows that
were occurring in the general market index at that time (passage of
Re-accumulation Test Number Five). Moreover, at point #28 and #31
price met support near the 1/2 retracement level of the move from
point #20 to point #27 (1/2 mark on Chart 1), thus fulfilling Reaccumulation Test Number Six. At either point 28 or point 31, the
trader would have had a better than 3-1 reward to risk ratio (14 count
vs. 3-4 points of risk) for the passage of Re-accumulation Test Number Nine.
The trader under the foregoing re-accumulation circumstances
should have (and did) roll his options contract forward to a later
expiration and higher strike price. He simultaneously increased the
size of his line. The passage of all nine re-accumulation tests had
created a compelling enough case for him to roll his option contracts forward at the $35 strike and to add to his position.
FAILED TESTS
To illustrate the new list of modified Wyckoff Tests for Re-accumulation that appear in Side Bar #2, let us return to the case study of
the SF Company. After the base had been completed, the Wyckofforiented trader entered a long option position at point #18 on the SF
charts. The SF stock then moved up sharply from point #18 to point
#19, where it encountered enough supply to halt its advance, and so
SF entered a period of hesitation and sideways movement starting at
#19. This period of hesitation commenced with a buying climax
around point # 19, which would also have alerted the trader of the
possible onset of re-accumulation before resumption of the upward
trend or even possibly distribution leading to a reversal of trend. The
trader, who was actually operating in SF at the time of this case study,
recounted his upside figure chart objective to $49 and chose to wait
out is interruption in the trend.
At point #20 the trader observed a Spring situation and so presumably he could have ventured a long position around the $29 level
(see Active Trader magazine, August 2000, for Springs and Upthrusts). At this juncture he could have consulted side bar #2 for
the checklist of Re-accumulation Tests. At point #20, he could have
concluded that Re-accumulation Buy Tests Number Two and Number Three had been passed. At point #20 the volume had dried up
considerably and the downside price progress was minimal, which
CONCLUSION
* Examples of these and other tests for re-accumulation are available in the Wyckoff
literature. In Basic Lecture Number 12 of the SMI/Wyckoff course, for instance, the
narrator counsels the student to place resting buy orders at the 1/2 re-tracement level
in order to add positions during corrections in a bull market. Elsewhere in the Wyckoff literature the student is admonished to purchase when the price intercepts and
encounters support along an important upward slanting demand line.
MTA JOURNAL
When SF reached the $49 level, the trader exited his SF options
position. He judged that the relatively high volume occurring in the
price-objective zone around $49 was sufficient reason to exit. To make
Spring-Summer 2001
53
After having identified a Sign of Strength (SOS) on the vertical

line chart, locate the last point at which support was met on a
reaction the Last Point of Support (LPS). Locate this point on
your figure chart also and count from right-to-left, taking your
most conservative count first and moving further to the left as the
move progresses.
In moving to the left, turn to your vertical line chart and divide
the area of accumulation into phases, adding one complete phase
at a time. Never add only part of a phase to your count. Volume
action will usually show where the phase began and ended.
As the moves progress you will often see a lateral move forming at
a higher level. Very often such a move will become a Stepping
Stone Confirming Count of the original count. Thus, as such an
level forms, you can often get a timing indication by watching the
action of the stock as the potential count begins to confirm the
original count. A resumption could begin at such a point.
For longer term counts one should add his/her count to the exact low, or a point about one-half way between the low and the
count line. You will thus be certain that the most conservative
count is being used.
Counts are only points of Stop, Look and Listen, and should
never be looked upon as exact points of stopping and turning.
Use them as projected points where a turn could occur, and use
the vertical line chart to show the action as these points are approached.
In the case of a longer-term count, often the Last Point of Support (LPS) comes at the original level of climax, and this level
should be looked at first in studying the longer term count. The
climax itself indicated a reversal, with the subsequent action being the forming of the cause for the next effect. For the Last
Point of Support (LPS) to come at such a level of climax usually
makes it a more valid count. Very often the climax is preceded by
preliminary support and the Last Point of Support often occurs
at the same level as the preliminary support.
A #3 Spring or the Secondary test of a #2 Spring, quite often constitutes the Sign of Strength and the Last Point of Support in the
same action which is reached at the same point and at the same
time. Usually a Spring will be followed by a more important Sign
of Strength and the reaction following that Sign of Strength is
also a valid Last Point of Support.
Frequently, long term counts on three- and five-point charts are
confirmed by subsequent minor counts on the one-point chart as
the move progresses. Watch for this confirmation very carefully
as it often indicates when a move will be resumed.
In case of three-point or five-point charts, the same count line
should be used as for the one-point chart.
Analysts who wish to use the Wyckoff Count Guide must appreciate and comprehend certain philosophies and procedures unique to
the Wyckoff figure chart. Four key elements of Wyckoff figure chart
analyses are as follows:
1. Figure charts play a special supplementary and complementary
role in the Wyckoff Method. The key law of Supply and Demand
relies upon the vertical chart to diagnose the present position and
future trend of the market. The figure chart is not used per se for
determining the trend of the market, because the volume information of the vertical chart makes it a superior tool for determining the trend. Philosophically, Wyckoff analysts believe the verti-
the case for exiting even more enticing, the general market index
had started to weaken and diverge from the higher price set by SF
around $49.
There were targets outstanding at $51-$57, but this Wyckoff-oriented trader elected to take his profits at $49 because that was the
maximum effect of the cause built during the re-accumulation stepping-stone-count along the $35 line (point #22 to point #31). He
reckoned that he would have to weather another sideways to down
correction/consolidation as further preparation for the final advance.
He further reckoned that the risk did not justify waiting to capture
the final 8 points available beyond $49. Of course, as we can see
retrospectively, he exited prematurely because SF promptly advanced
to $54. (Upon further reflection, this Wyckoff trader said that he
would do the same thing again because bulls make money, bears
make money, and pigs get slaughtered.)
The case study of the San Francisco Company (SF) demonstrated
how, with the help the Wyckoff Nine Classic Buying Tests, an option trader could have entered favorable reward-to-risk long positions
just as the line-of-least resistance became defined with the passage of
the Nine Classic Tests for accumulation and as the stock was leaving the base formation. This case study also demonstrated how an
option trader could have later employed a new set of the Nine Reaccumulation Tests to both roll his contracts forward and to add to
his position. The fulfillment of the stepping stone confirming count
nature of this re-accumulation consolidation gave the trader added
reason to hold on to his positions until his longer-term base targets
were being reached at $49. Furthermore, the stepping stone confirming count provided an additional compelling reason for him to
exit his long options on the burst of strength as SF reached the $49
level.
In general, the Wyckoff Nine Classic Buying Tests and the set of
Nine New Tests for Re-accumulation can help investors and traders
to advance forward in their quest to control risk, ride winners and
take home maximum profits.
APPENDIX TO WYCKOFF TESTS

How to Make Price Projections Using a Figure Chart
by Prof. Hank Pruden, Ph.D., Golden Gate University
The average ticker hound or, as they used to call him, tapeworm goes wrong, I suspect, as much from overspecialization as
from anything else. It means a highly expensive inelasticity. After
all, the game of speculation isnt all mathematics or set rules, however rigid the main laws may be. Even in my tape reading, something
enters that is more than mere arithmetic.
- Reminiscences of a Stock Operator
The Wyckoff Method rests upon three main laws: (1) the law of
supply and demand, (2) the law of effort vs. result, and (3) the law of
cause and effect.
According to the Wyckoff Law of Cause and Effect, the traderinvestor-analyst measures the extent of the cause built up during a
trading range and then projects a price objective the potential effect
of that cause. The relationship between the cause and the subsequent effect is one-to-one, which means that every unit of cause that
is measured horizontally in a trading range translates into an expected
one unit of vertical effect.
The cause is created during the up and down buying and selling
waves that occur during a trading range.* The cause is measured
and projected on the figure chart according to the Wyckoff Count
guide. The Wyckoff Count Guide is stated as follows (Source: Wyckoff/Stock Market Institute):
MTA JOURNAL
* For readers who recall their high school physics lessons, the law of the cause and
effect can be likened to Hooke's Law of Elasticity. Hookes Law declares the agitations up and down build up energy, the cause (e.g. agitating a metal coat hanger back
and forth) and the resultant effect (bend the hanger out of shape) expends energy in
an exactly one-to-one proportion to the preceding energy built up.
Spring-Summer 2001
54
cal chart ought to be used for trend analysis; however determining the potential extent of the move is the special provence of the
figure chart, sometimes referred to as the cause and effect chart.
2. Procedure. The building blocks of the figure chart are box size,
intraday data, number of reversal points and full-unit crossing.
Most commonly the box size is one point. Hence, intraday price
action must meet or exceed the full price levels to trigger a figure
chart entr y.
Reversal points are normally one point or three-point. For the
one point figure chart, a very special consideration to keep in
mind under the Wyckoff figure chart procedure is the necessity
of having at least two entries in any column. Many software programs change columns when price changes direction, even if only
a single entry exists in a column. To compensate for this, the
analyst must shift prices to create a column with at least two entries in a column before price can move to the next column. Hence
a quick down, up, down of one point each would remain in a single
column.
For larger moves, the analyst has the option to either relying upon
the three-point reversal or an increase in the box size.
3. Perspective. The analyst can visualize horizontal counts as fitting
within a saucer appearing bottom and a dome looking top. The
first count line should be conservative, nearest the lows, and be
considered as the minimum possible. The next count line will
usually be within the trading range, broader, and considered the
likely objective. Finally, the pullback following the upside jump
or valid/breakout creates the widest count and the highest upside count, and is thus the least conservative measurement (this is
the last-point-of-support that follows after a more important signof-strength).
MTA JOURNAL
REFERENCES
Forte, Jim, CMT, Anatomy of a Trading Range, MTA Journal,

Summer-Fall 1994
Hutson, Jack K., Editor, Charting The Market: The Wyckoff
Method, Technical Analysis, Inc., 1986
Mathis, David, Santa Fe: A Classic, audio tape and charts, Stock
Market Institute, 1978
Pruden, Henry O. (Hank), Ph.D., Trading the Wyckoff Way:
Buying Springs and Selling Upthrusts, Active Trader magazine,
August 2000
Pruden, Henry O. (Hank), Ph.D., Wyckoff Axioms: Jumps and
Backups, Active Trader magazine, January-Februar y 2001
__________, Introduction to the Wyckoff Method of Stock Market Analysis Text Exhibits and Illustrations, Stock Market Institute, 1983
__________, Basic Lecture No. 12, audio tape and charts, Stock
Market Institute, 1968
BIOGRAPHY
Henry O. (Hank) Pruden, Ph.D., is Professor of Business and
is Executive Director of The Institute for Technical Market Analysis at Golden Gate University, San Francisco, CA, and he is also
Editor of the Market Technicians Association Journal. Hank can
be reached at hpruden@ggu.edu, phone 415/442-6583 and
www.hankpruden.com.
This article was reviewed, edited and approved by Mr. David
Upshaw, CFA, CMT, Associate Editor, MTA Journal.
Spring-Summer 2001
55

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THE MTA JOURNAL TABLE OF CONTENTS

MTA JOURNAL EDITORIAL STAFF

ABOUT THE MTA JOURNAL

MARKET TECHNICIANS ASSOCIATION, INC.

2000-2001 MTA BOARD OF DIRECTORS AND MANAGEMENT COMMITTEE

Henry O. (Hank) Pruden, Ph.D., Editor

NEW APPLICATIONS FOR OPEN INTEREST IN U.S. TREASURY BOND FUTURES:

Sal Greco, CFA, CMT

APPLYING VODOPICH'S INTEGRATION OF ELLIOTT AND GANN TO THE

William K.N. Chan, CFA

INTERMARKET BREADTH I NDICATORS: DOES THE PRICE ACTION OF I NTEREST RATE

Gary Stone, CMT

Jordan E. Kotick, B.A (Hons), M.A., CMT

A CRITICAL STUDY ON THE EFFICACY OF STOP-LOSS

THE METAPHYSICAL IMPLICATIONS OF THE E LLIOTT WAVE PRINCIPLE

Henry O. (Hank) Pruden, Ph.D.

THE MTA JOURNAL

Jeffrey Morton, M.D. CMT

Charles D. Kirkpatrick, II, CMT

Richard C. Orr, Ph.D.

ABOUT THE MTA JOURNAL

A NOTE TO AUTHORS ABOUT STYLE

MARKET TECHNICIANS ASSOCIATION, INC.

BENEFITS OF THE MTA

Invitation to MTA educational meetings

Annual subscription to the MTA Journal for nonmembers:

$50 (minimum two issues).

Single issue of the MTA Journal (including back issues):

$20 each for members and affiliates and

2000-2001 BOARD OF DIRECTORS AND MANAGEMENT COMMITTEE

(4 Officers, 4 Directors & Past President)

(4 Officers, Past President and Committee Chairs)

Philip B. Erlanger, CMT

David L. Upshaw, CFA, CMT

Henry (Hank) O. Pruden, Ph.D.

Director: Vice President

Neal Genda, CMT

Daniel L. Chesler, CTA, CMT

Dodge Dorland, CMT

Bruce M. Kamich, CMT

Charles Kirkpatrick II, CMT

Philip J. Roth, CMT

Kenneth G. Tower, CMT

John C. Brooks, CMT

Philip J. Roth, CMT

Lisa M. Kinne, CMT

Bruce M. Kamich, CMT

John Kosar, CMT

M. Frederick Meissner, Jr., CMT

George A. Schade, Jr., CMT

APPROACHES TO THE BODY OF KNOWLEDGE IN

NEW APPLICATIONS FOR OPEN INTEREST IN U.S. TREASURY

panying specific price action. These principles represent the basic

Figure 2 Interpretation of Price/Vol/OI Interplay

TWO FRAMEWORKS FOR OI ANALYSIS

Common Major Interpretation

Rising OI in an Uptrend is Bullish

New Longs and New Shorts Entering

Decling OI in an Uptrend is Bearish

Short-Covering and/or Long Selling