STOCHASTICS REVISITED

The Stochastics we studied earlier did not prove to be a useful indicator. But using brute force computer calculation there may have been a combination of profits, i.e. we found the 39 day Stochastics to be profitable using a simplistic rule. Buy the stock when Stochastics K moves above the 50% line, provided that both the price and Stochastics K have made a new high, and sell/ sell short the stock when the K stochastics moves below the 50% line provided again that both the price and K stockastics have made a new low.

This simplistic rule did uncover some gains worthwhile to notice them. There is no smoothing of the K in this decision rule, thus only the value Stochastics K is used to signal trades. The above rule did provide some consistent results for medium values of K, while it was not profitable for low values, or higher values of K.

One bad point was that there was only 40% of the trades which produced profit while the other 60% produced losses. Still, this indicator was profitable in the end.

RELATIVE STRENGTH INDEX

Relative strength Index or RSI is a complicated indicator. It is evaluates as follows:

RSI = 100 - [100 / (1+RS)] where RS is the ratio of exponentially smoothed moving average of n- period gains, to exp. smoothed moving average of n- period losses.

RSI only takes into consideration the close price of the stock. This indicator takes many values from the past so it may be seen as better than other indicators which may take only one value from the past i.e. the ROC for example. Therefore, we can say that RSI is more reliable than other indicators though again the RS value ratio may complicate things by adding some noise and make the indicator sometimes unreliable.

The RSI does not work well with small values of n and it works better with higher values of the period n, therefore it is better to work with high values of n.

One way to use RSI is to buy when the RSI crosses above 50%, while to sell when RSI crosses below 50%. For n = 21- day the best results were manifested in backtesting trials. In this setting, in overall, this indicator fared well in the backtesting trials thus, it may be a good tool to use for trading.

VOLUME ACCUMULATION OSCILLATOR

The Volume Accumulation Oscillator has been created by Mark Chaikin. It is a rather complicated formula represented as follows:

VAO = [Close price for a period n - (High price for a period n + Low price for a period n) / 2] * Volume for same period n

VAO = [Cn - (Hn + Ln) / 2] * Vn where n is the period.

What this indicator tries to do is to express the Close price for the period n as a percent of the High and Low of the same period and then weighted, or multiplied by the compounding Volume of the same period.

Right from the beginning, we can say that because volume is a value that often can be erratic, this indicator may suffer from the whimsical ups and downs of the multiplication by the Volume. Perhaps if Volume is smoothed out with a Moving Average may bring better results.

We tested this indicator with doing backtesting and what we found was that the indicator indeed is erratic, i.e. the curves created by n versus equity, were not smooth but jumped high/ low depending on n. Long periods of n, i.e. at n being from 30 to 100 poor results were produced.

Therefore, we cannot say that this indicator is a reliable indicator. Also we see no value to it as it behaves at low standard depending on other indicators. Even smoothing the results with moving averages did not produce any good results therefore, the conclusion can be said that the indicator is not of much value to the stock trader.

INTEREST RATES AND STOCK PRICES

An interesting association may be uncovered if we test the interest rates of government securities with the stock market. Using monthly or weekly data we uncover that predicting stocks using the rate of change of interest rates, i.e. the one month rate of change which is the current value subtracted from the previous month rate of change, is a profitable system as well as the weekly rate of change, i.e. the 2 week rate of change produced the best results. These two systems produced positive profits that were quite high. Therefore, we can say that the 1 month rate of change of goverment interest rates as well as the 2- week rate of change of the same government securities is producing good results. Results showed that interest rates needed to move quite higher before they were able to influence the stock market. Small changes to the interest rates did not show any association with the stock market, therefore, in the end the interest rates ROC may not be a useful indicator, unless the interest rates raised, or lowered substantially.

Another association can be made that when interest rates are low, they show profitability towards the stock market, but when they are raised above a theshold value then they begin to influence the stock market. Therefore, low values of government interest rates do not have any correlation with the stock market. Interest rates need to move to higher values rather than stay at low values in order to have influence with the stock market.

DIRECTION OF SIMPLE MOVING AVERAGE

The Moving Average is a popular indicator and here we take a view at how it works when it changes direction, i.e. falling, or rising.

This indicator is the same as the Rate of Change ROC, because when the ROC crosses zero the same event works with the moving average, i.e. it changes direction. We shall not follow both here, only the Moving Average changing direction.

Some backtesting done proves that the n-day optimal for Moving Average changing direction is 31 days, i.e. the same optimal n for the ROC indicator. Since it is redundant to follow both indicators, the reader is refered to the post we already made about the ROC.