Predicting the Market from the Inside Out: New Breadth Measures
I always wondered if it was possible to predict the market better from the inside out by looking at the constituent stocks of the index to generate signals. After all, it seemed that everyone used breath indicators in some form or fashion. I did quite a bit of research using classic breadth indicators and came up with only a handful of of indicators that actually worked better than simply using timing on the market itself. Of course, (as some of you know) I have a very persistent and almost stubborn desire to solve research problems. I won’t give up until I feel I have exhausted all the logical and simple hypotheses that can be tested. Unlike the typical scientific skeptic who writes everything off before testing (ok its an oxymoron but true!), I like to keep an open mind and have the opinion that if enough people claim that something is useful it is worth examining in a serious way.
In this case, after spending time formulating the confounding variables, I had the breakthrough moment. As it turns out–not all stocks are equal, and classic breadth measures assume that each stock gets an equal vote. In reality, when we try to measure breadth, we are attempting to gauge a broad flow of money in order to have a clearer picture of the market. We are looking at buying and selling power on the premise that it is difficult to hide what is happening across a wide variety of stocks. One of the factors in the Livermore “Active Issues” rankings relates to volume activity. I decided that I would apply this proprietary variable as a filter to identify the stocks worth focusing on. Once I used this approach, suddenly breadth appeared a lot more powerful. So I decided to take it one step further—why not apply an adaptive indicator to the constituent stocks to improve timing signals? Well as it turned out the sum of the parts beat the whole—using the indicator on the selected stocks to generate signals to trade the market outperformed using the the same indicator to trade the market on its own!
now that is good!—-to be continued soon