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Modified VWAP Methodologies

New Research: Essay Six (continued)

Essay on MIDAS/AC Fourth Generation (Gen-4) Curves (continued)

© Andrew Coles

MIDAS/AC Gen-4 RS Curves (continued)

I’ll complete the chart studies on this page with two further illustrations and then summarise Gen-4 curves in a short conclusion.  

Fifth illustration: Applying Gen 4 curves to the Gold/Oil Ratio (using ETFs)

The Gold/Oil ratio is another RS study recommended by Murphy in relation to the assessment of different commodity groups such as metals and energy. In recent years, Ashraf Laidi has argued that the Gold/Oil Ratio has an inverse relationship with risk appetite, stock market gains, and market sentiment. More precisely, when gold (the numerator) begins to fall, energy prices reemerge relative to metals, which in turn reflects improved risk appetite and higher growth. Laidi recommends the ratio particularly during the early stages of a rebound. I cited Laidi’s book alongside Murphy and Pring at the beginning of this essay.

Again, regardless of the precise and detailed macroeconomic interpretations of this ratio, our main interest is in the performance aspect of the RS line in relation to hidden inflection points (HIPs) and out-of-reach inflection points (RIPs). With this in mind, let’s examine Figure 11, a daily chart between 2007 and 2013 of the iPath S&P GSCI Crude Oil TR Index ETN (OIL) divided by SPDR Gold Shares (GLD).

My main interest is in points (1) and (2). At point (1) gold is outperforming oil despite the dramatic surge in oil in the lower pane. This outperformance allows the Gen-4 curve to resist the parabolic uptrend in oil in a series of out-of-reach inflection points (RIPs). When oil does eventually peak in mid-2008, the event is signified by a substantial break of the two Gen-4 curves.

At point (2) on the far right, oil is again underperforming gold into 2014 and this allows the anchoring of two new Gen-4 curves which again resist oil in relation to the new RIPs being formed. The latter are important here because we can see in the lower pane that the OIL ETN is flat and thus incapable of supporting or resisting conventional MIDAS curves.

Figure 11: Two significant periods of underperformance by the OIL ETN again allows the application of Gen-4 curves and their identification of RIPs

Sixth illustration: Unconventional Intermarket Ratios (here the euro versus gold)

By this stage, readers will probably conclude that for Gen-4 curves to work consistently, they must be applied to the very conventional RS lines used so far in this essay and by other established intermarket analysts. This however would be a wrong conclusion to draw. In fact the opposite is true: the more unusual or obscure the intermarket relationship being studied, the more unique the hidden and out-of-reach inflection points become. Indeed it is possible to create a truly unique and individualised market timing model and trading system if the analyst goes out of his or her way to seek out these uncommon and never considered relationships. Prior to the conclusion, I’ll end this study with just such an uncommon relationship, namely the euro against gold. This is an unusual RS line to create because most traders believe rightly that the euro and gold move largely in the same direction. This of course is true but it misses the point. The main point centres again on underperformance and outperformance, and how these two constantly changing relationships create the HIPs and RIPs we’re seeking.

To illustrate this point, Figure 12 is a daily chart between 2005 and 2013. In the bottom pane I have the Currency Shares Euro Trust (FXE) and in the upper pane an RS line of FXE divided by the SPDR Gold Shares (GLD). My main interest is in the box highlighting the period between early 2008 and late 2011. During this period, there are four primary trends in FXE creating a large, angular zigzag patten that for a time is relatively directionless. By contrast, gold is outperforming the euro in the upper pane during this period, creating a smooth downtrending RS line. This is perfect for the application of Gen-4 curves, several of which are launched from mid-2008 onwards. As we see, the curves resist all of the major swing highs in FXE during this time. Again these out-of-reach inflection points (RIPs) are by definition entirely beyond the application of any standard MIDAS curves, yet the signals they create are timely, robust and perfectly accurate.

Figure 12: Major swing highs in FXE between 2009 and 2011 are out-of-reach inflection points (RIPs) but they are still accessible to Gen-4 curves

Conclusion and Summary

This essay had three aims: (i) to draw together work published elsewhere; (ii) to emphasize to an even greater extent just how extensively Gen-4 curves can be applied to financial datasets; and (iii) to highlight market signals (and potential trading systems) that cannot be duplicated in other indicators or indeed in any other generation of MIDAS curve. As noted in the introduction, MIDAS/AC Gen-4 curves thus represent another very exciting development in the MIDAS project and provide extensive opportunities for new types of analysis.

With regard to aim (iii), I have specifically attempted to highlight certain important and recurrent behaviour patterns in Gen-4 curves, regardless of the datasets to which they’re applied. These recurrent behaviour patterns are summarised below.

MIDAS/AC Dipper Setup

The first of these behaviour types is embodied in a trading setup I have called the MIDAS/AC Dipper Setup. This setup is discussed briefly in Chapter 16 of the MIDAS book in relation to the OBV indicator and also briefly in my two Active Trader articles cited earlier in the essay.

In this essay I have illustrated the Dipper Setup on MIDAS/AC Volume Curves, MIDAS/AC Momentum Curves, and MIDAS/AC Economic Curves. The Dipper Setup can also be found extensively on MIDAS/AC RS Curves, MIDAS/AC Volatility Curves, and MIDAS/AC Sentiment Curves.

Additional Treatments

Before attaching Gen-4 curves to certain datasets, the data can be subjected to further treatment so that the Gen-4 curves work more effectively. So far, I have applied this treatment to certain well-known market volatility indicators and market sentiment indicators. For now this treatment remains proprietary so I will not pursue the topic of further treatments here.

MIDAS/AC Numerator Under-Performance Setups (NUPs)

To summarise, NUPs occur when the RS line is falling, which means in turn that the numerator is declining and that the denominator (often in intermarket analysis a broader market benchmark) is increasing. When this occurs, Gen-4 curves can be anchored to the swing highs of the declining RS line and there are then two possibilities:

MIDAS/AC Numerator Out-Performance Setups (NOPs)

To remind ourselves, NOPs occur when the RS line is rising, which means in turn that the numerator is rising and that the denominator (often in intermarket analysis a broader market benchmark) is declining. When this occurs, Gen-4 curves can be anchored to the swing lows of the rising RS line and then again there are two possibilities:

MIDAS/AC RS Line Rising or Falling while the Market is Trendless Setups (RMTs)

Readers will recall that there were certain charts where the RS line was either rising or falling while the market asset in the lower pane was moving sideways. Sideways markets don’t work with MIDAS curves unless my MIDAS/AC Displacement Channel is used. But Gen-4 curves can also get around this problem. Let’s look again at two possibilities:

Again this is to remind visitors that the above work is the intellectual property of Andrew Coles and that no unaccredited use of any of this material is permitted. - © Andrew Coles


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