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.5 percent.Using the 200-Day Moving Average1.If the 200-day moving average line flattens out following a previous decline or is advancing, andprices break out through the moving average on the upside, then these events constitute a long-term buysignal, as shown in Figure 10.8.2.If the 200-day moving average flattens out following a previous rise or is declining, and pricespenetrate the moving average on the downside, these events constitute a major long-term sell signal.The single biggest problem with the 200-day moving average is that it is such a heavily lagged indicator.Asyou can see in Figure 10.8, by the time the 200-day moving average indicated buying or selling on the DowIndustrials, most of the move was over.In addition, it is virtually worthless in protecting you from sudden crashes orminicrashes after a sustained, speculative market climb.For that reason, I use the 200-day moving average only as asupporting technical tool.If, for example, the OTC Composite index had, among everything else, also broken belowthe 200-day moving average, I would have been short the world on the OTC stocks in late March and early February.Instead, I only held a moderate short position.Breadth and Momenturn OscillatorsThe final two indicators I use are breadth, or the advance-decline line (the AID line) as it is sometimes called,and momentum oscillators.The AID line is simply a plot of the difference between the total number of advancing issues and the totalnumber of declining issues.It is important because it is an indicator that compensates for virtually all stock averagesbeing weighted.The Dow, for example, is an average of only 30 stocks, weighted to price.Sometimes, if a heavilyweighted157(D Copyright 1993 COG INC. FIGURE 10.8 Signals of the moving average.stock, like IBM, makes an unusually extensive move, it can throw off the validity of the average as an indicator ofperformance of industrial stocks as a whole.As a general rule, the A/D line's daily movements follow the general direction of the broader averages, andwhen they don't, the discrepancy often signals a coming change in trend.In fact, I use it virtually like another average,applying Dow Theory principles in analyzing it versus other indexes.However, the daily A/D line only has to confirmthe previous high (or low), not the high or low you're comparing it with.Also, the weekly A/D line should confirmyour bullish or bearish convictions.For instance, the best technical indicator since the October 1990 low has been,without exception, the weekly A/D line.As another example, in March and April 1992, the Dow was making newhighs, while the OTC Industrials, the S&P 500, and breadth were not.I viewed this situation as a possible divergence,indicating the possibility that the Dow might be approaching its top.158I always watch breadth closely, treating it as a near equivalent of any other stock index.I put secondary weighton a measurement derived from it, a momentum oscillator that measures the general upward or downward bias of themarket as a whole.Every day, I keep a running, cumulative total of the daily difference of advancing minus decliningissues for the previous 30 trading days on the NYSE.Then I divide the result by 3 to get the 10-day equivalent, netchange, moving average breadth oscillator.It is quite often an effective measure of the intermediate term "overbought"or "oversold" condition of the markete6As with the 200-day moving average, I use breadth and momentum oscillators as secondary, supplementaltools to augment more fundamental technical measures as the 1-2-3 criterion, the 2B rule, and the life-expectancyprofiles in determining the overall odds of success.For example, in late February and early March, breadth was failingto make new highs and the overall market was in a mildly overbought condition according to my long-term oscillators.Thus, breadth was supporting my short position in the OTC market, and my oscillators were mildly supporting it.In neteffect, the overall odds were in my favor, but not heavily enough to take an aggressive short position.At no time wasmore than 2 or 3 percent of my own or my clients' capital at risk.A NEW EXCELLENT INDICATORI hope you feel that I've contributed some solid ideas and money-making suggestions in this book.Now I'mgoing to add one more: the 4-day rule.It is my favorite intermediate indicator of a change in trend, and I decided toshare it because I feel some attachment to all the people who have read and commented on my previous book, TraderVic-Methods of a Wall Street Master.As usual, the discovery of this rule involved a great deal of painstaking work.I made a study of the Dow JonesIndustrial average from 1926 to 1985, and measured every top and bottom in that time from an intermediate point ofview.Table 10.1 shows the correlation of tops and bottoms with 4-day sequences (that is, 4 up or 4 down days in arow).looking at all the data, I made two observations.159Table 10.1 1926-1985 4 Day Rule Samples (Intermediate Moves)No.of Days Frequency Occurrence (%) Composite (%) 160Table 10.1 (Continued)No.of Days Frequency Occurrence CompositeNo.of Days The number of days after the high or the low that the 4-day sequence began.Frequency The number of occurrences between 1926 and 1985 that the 4-day sequence began a particular number of days after the high or low.Occurrence The percentage of highs or lows that were followed by a 4-day sequence starting the given number of days after the high or low.Note that 10 percent of all intermediate moves had no 4-day sequences.The Four-Day RuleWhen the market has a reversal, in the form of a 4-day up or down sequence from a high or a low, after anintermediate move has taken place, the odds of the trend having changed is very high.The first observation is that a 4-day sequence associated with an intermediate top or bottom almost alwayspoints you in the direction of the trend.As Table 10.1 shows, 25 percent of the intermediate highs or lows wereimmediately followed by a 4-day sequence in the direction of the new trend, 41 percent were followed by a 4-daysequence within 6 days, and 75 percent had a 4-day sequence within the first 24 days.Only 10 percent of theintermediate moves did not contain a 4-day sequence in the direction of the trend
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