The process to detrend a cycle is simple.
1.
Calculate a moving average the same length as the potential Trading
Cycle. For most markets use a 20-bar
moving average of the close. But instead of plotting the moving average on the
day of the last calculation, it is centered (or plotted) in the middle of the
cycle. For example, the 20-day moving average is plotted back 10 days from the
most recent close. This is called a centered moving average as it is plotted in
the center of the cycle.
2.
Subtract
the moving average from the high and low of each price bar and plot the results
around a zero line directly below each price bar. The zero line represents the
centered 20-bar moving average.
3.
The
centered detrend at the bottom of Chart 3 mitigates the effects of trend and
allows the highs and lows of the trading cycle to be easily seen.
This
process can be easily programmed into many of the popular trading platforms.
The two indicators for this detrending process can be downloaded from our
website Download Page for TradeStation and SuperCharts users WB_Cen-MA indicator, which calculates
the moving average and centers it back one-half the length of the cycle as in
Step 1. The actual centered detrend is plotted by the WB_CenDetrend indicator as in Step 2.
Chart 4 - The chart below has been compressed to show more cycles. The highs
and lows of the centered detrend correspond to the highs and lows of the
trading cycle. Most cycle tops occur above the sell line at .80 and most cycle
bottoms occur below the buy line at -.80.
A rise above 2.0 indicates a top is imminent; a bottom is ready to occur
if the detrend drops below 2.0.
If you are thinking that this is the
indicator for which you have been searching… there is one problem. Because the
centered detrend lags prices by one-half the length of the cycle, or 10 bars,
the centered detrend is excellent for showing historical cycles, but cannot be
used for real-time trading.
However, we now
have something to look for -- A real-time oscillator that matches the centered
detrend and the cycles.
OSCILLATORS SHOW CYCLE TOPS AND BOTTOMS
Chart 5 - The standard oscillators in TradeStation,
SuperCharts or any charting package can be overlaid on the centered detrend (or
on top of prices) in the search for an oscillator that tops and bottoms as the
trading cycles top and bottom. Not surprisingly, the performance of these
oscillators for identifying trading cycle tops and bottoms can be improved by a
few simple techniques.
To
use an oscillator to identify cycle tops and bottoms look for three
characteristics:
1. Â
The
oscillator turns when prices turn
2. Â
The
oscillator does not “wiggle” much at cycle tops and bottoms
3. Â
The
oscillator has amplitude moves that take it to the extremes of an allowable
range as the cycles bottom and top.
Overlaid
on the centered detrend (CDT) is such an oscillator. It is a regular RSI 3
smoothed with a 3-bar moving average called the RSI3M3. It shows the bottoms
and tops of the trading cycle almost as well as the centered detrend and can be
used as a mechanical trading signal and cycle identifier… And the RSI3M3 is
current to the most recent price bar, turning down in this chart to identify
the most recent trading cycle top missed by the centered detrend.
Category: Methods of technical analysis
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