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MONITORING STOCKS

Now let's apply the same method to stock trading, with minor modifications. Now, because a single stock is generally even more volatile than a mutual fund, use the following rules:

Go long only if:

1 The MACD of the weekly stock/S&P ratio is greater than zero, and

2 The MACD is above its trigger line.

The MACD line is the difference between the two moving averages; the result of measuring the difference between the two moving averages is a leading indicator of the relative strength ratio.

I added the additional rule requiring the MACD to be in positive territory to increase the chance that the performance of the stock compared with the S&P index has improved in a meaningful way.

Figure 3 is a recent example of trading the security Nike (NIKE) with this technique.

Again, you have the option of switching to money market funds or Treasury bills after sell signals if you are conservative, or into another stock on a buy signal if you are aggressive.

You can go short using the inverse of the same rules, but I recommend that you be sure that the

fundamentals of the stock support the technical signals.

ASSET ALLOCATION

Another application is in asset allocation. This technique can be applied to a portfolio of stocks to decide how much capital should be in stocks and how much should be in money market funds.

For example, if

you monitor 50 of your favorite stocks and 35 have sell signals, you might well decide to reduce your equity portfolio to only 30% invested. In addition, if your investment horizon includes foreign stocks and if 70% of your US stocks are on sells but 65% of your foreign stocks are on buys, you might decide to increase your foreign allocation.

The same approach can be used for foreign equity mutual funds. When the relative strength ratio-MACD crossover is positive, foreign funds should be considered and analyzed by their performance relative to the S&P, or the Europe, Asia and Far East Index (EAFE). This analysis will help you avoid long trendless periods in foreign equities that in the past have lasted for years, at least in dollar-denominated funds.

Finally, if you do what I prefer to do — that is, follow the relative strength ratio/MACD of the S&P sector indices (Figure 4) — you might find that, as an example, energy stocks are outperforming software stocks and make appropriate adjustments such as purchasing energy stocks (Figure 5).

CONCLUSION

The relative strength ratio-MACD crossover indicator is an effective tool with which to screen stocks and mutual funds based on performance. Calculating the indicator and the rules are straightforward and can be easily tested in most software. I have found this to be a useful and precise investment timing and portfolio allocation tool.

Gilbert Raff, is president of MarketSpace Financial, a money management firm located in Albuquerque,

NM.

FIGURE 3: NIKE. Equities tend to be more volatile than mutual funds, and therefore, buy signals incorporate the added rule that the MACD line be in positive territory. While this may increase the chance of late entries, it will reduce the likelihood of false signals.

FIGURE 4: ENERGY SECTOR. You can apply the relative strength ratio-MACD crossover indicator to market indices to identify which sectors are outperforming the S&P 500. Here, the S&P energy sector was a strong performer in early to mid-1993 and then underperformed for the rest of 1993.