|
|
This month’s Trade Secret has been submitted by Mr. Charles K. Langford Vice-President, Portfolio Overlay Management for The New Providence Portfolio Management Ltd. Mr. Langford has been giving seminars and lectures on risk management of e xchange-traded and over-the-counter stocks, bonds and derivative instruments since 1975. He holds an M.A. degree from McGill University . He is also Fellow of the Canadian Securities Institute. He has published hundreds of articles and a dozens of books on options strategies, technical analysis, risk management of long- term and short-term interest rates and portfolio management.
“Two horrible months!” Mr. Wilson said with a mixture of sourness and disappointment. A young investor, only 21 years old, Mr. Wilson was alluding to March and April. I had met him at a conference on technical analysis, and the cause of his unhappiness was the XIU (SP/TSE60 index).
In January and February he had experienced a marvellous dream. Early in 2005, he bought 200 shares of XIU at $50.00 each. This was his first equity investment. Choosing the index was a necessity: how else to diversify a stock portfolio with only $10,000? The only way was to buy a stock index, which would include Canada ’s 60 most conservative stocks. He thought this would protect him from the risk of a downward trend: the XIU represents the country’s productive forces, meaning it could only rise.
As if by a stroke of magic, this ETF (exchange traded fund) had started to go up: a steady and resolute rise, without volatility, going up in a straight line at 60–degree angle. This moved the price beyond $55.00 at the beginning of March, representing a 10% profit in two months, or a return of 60% in one year.
At first, Mr. Wilson could scarcely believe his success; but he gradually became accustomed to profit and, by the end of February, was convinced that he could rely on his talents as a financial wizard to build a better future easily and quickly.
But then the shadow of Mr. Dow’s old law approached. ”Everything that goes up must come down” stated the 1896 law that Mr. Wilson was still not aware of. This is why, even as prices began falling at the beginning of March, he still didn’t believe in a downturn and felt he could not be wrong! But by mid-April the XIU had fallen to $51.50.
If Mr. Wilson had applied the Langford sequential method, he would have saved himself this disappointment. Here is how he should have proceeded:
1 - The first step consists of looking at the behaviour of the Relative Strength Index (RSI) compared to the bar chart. The goal of this exercise is to discover if the current price trend shows signs of exhaustion. The aim is not to close the position but to have a realistic portrayal of the situation. The RSI line from January to mid-February rises along with the XIU price. But from mid-February to early March it fails to reach new highs: it is heading down. The price graph shows just the opposite. The XIU goes up, at an even faster pace. This divergence of behaviour is illustrated in the graph by the two dotted lines labelled with the letter A in the RSI and in the bar chart. This diverging behaviour anticipates the end of the current trend: the probability of error in this interpretation is almost zero.
A signal of weakening in the trend is also found at point G: the price produced a gap while on the rise, showing that the upward trend was strong. But the following day the gap had already been filled by the return of the price. This behaviour is contradictory: the gap of the day before should not have been filled so soon if the upward trend had still been strong.
2 - The second step consists of identifying signals that the trend is ending and consequently the moment at which Mr. Wilson should have sold his long position to lock in his profit. The Moving Average Convergence Divergence (MACD) gives the first signal that the current trend is ending: it is point “M” in the namesake graph. This occurs when the XIU is at about $54.00.
3 - If Mr. Wilson had waited longer, would he have had other sell signals? Yes, at the third step of the Langford method, the “official” sign of a new downward trend appears. This type of signal emerged in mid-March with these events:
- In the bar chart we see that between late February and mid-March the XIU completed a powerful downward configuration in the shape of a head and shoulders (the letters S, H, S in the graph). The configuration is completed at about $53.50, which thus becomes the “official” selling price.
-
Two days after the signal provided by this configuration, the two moving averages (point E) also crossed downward, at approximately the same price as the preceding point, confirming the sell signal. |
When I showed the Langford method to Mr. Wilson and to his fiancée, sitting beside him, she exclaimed: “Tomorrow is another day!”. This is the sentence that Scarlett O' Hara, the protagonist in the 1939 film Gone With The Wind, utters at the end of the movie to express confidence in the future following some very dark days, rich in experience. Tomorrow the market is still there to make money, if we use the right method .
June 15, 2005 Charles K Langford -
NPPM Ltd
| N.B.
This bulletin is offered for information purposes only. Investments
must meet each investor's objectives. Disnat does not issue any
recommendation about a product or give out any opinion on the
nature, suitability or potential value of an investment or of
any trading strategy. |
|
|
