[Ed. note: we are republishing the original Frank Roellinger article on the Modified Ned Davis Method with an up-to-date performance chart]
Introduction and Disclaimer
An earlier version of this article was submitted to Seeking Alpha but was rejected because it contained no “in-depth, fundamental analysis”. A brief search of the SA website disclosed references to fundamentally based articles on the Acting Man website. So I sent Pater a note claiming knowledge of a fairly accurate, purely mechanical method to identify significant long-term turning points in the market. I offered to tell him a few days in advance the target point of the next signal. He graciously offered to publish my article here. If it can be arranged, I will post its buy and sell signals as they occur in the future. This information is for educational and entertainment purposes only, it will never be a recommendation to buy or sell anything. But I believe that it will prove interesting to consider and watch over time.
Method Description
My method is similar to the so-called 4 percent method on the Value Line Geometric index, as first published by Ned Davis in the early 1980s. For those unfamiliar with this index, it is described here:
http://en.wikipedia.org/wiki/Value_Line_Composite_Index
Davis’s algorithm simply bought long any 4% or greater move up in the weekly closes of this index, and sold and went short on any 4% or greater move down in the weekly closes. His algorithm captured a good portion of every major move up or down, but, as is typical of a trend following method, suffered a number of whipsaw losses, primarily due to false sell signals. I tried a number of ways to reduce these and found two that worked well.
The first added feature uses a trend line. By dynamically constructing this line and deferring action until the market penetrated it, the method reduced whipsaw losses significantly, with little effect on total returns. I thus added this feature to the method.
The second improvement concerns short sales. Davis shorted on all sell signals. Unfortunately, most of these short sales did not end profitably. Using market breadth (advancing and declining issues on the NYSE) was found to better identify conditions for a short sale. My first pass modification identified every major downturn since 1961, except the plunge on 9/11/2001 on occasion of the WTC attack (which was hardly an economically based event), and prevented shorting of many of the smaller corrections. I added this feature to the method, unchanged from my first attempt.
Data Series
The farther an index moves (in percentage terms), the better it is suited for trend following. Davis probably was aware of this, and chose the Value Line Geometric index because it did move farther than other indexes available at the time, such as the Dow Jones Industrial Average and the S&P 500. Many small-cap indexes exhibit this tendency to make greater moves than their larger cap cousins, and are the basis for ETFs and futures contracts. Currently there are no ETFs or futures contracts based …read more
Source:: Acting Man
The post The Modified Davis Method appeared first on Junior Mining Analyst.