ENDIX
FIGURE A.5A COMPARISON OF THE CRB INDEX TO THE U.S. DOLLAR FROM LATE 1989 TO SEPTEMBER1990. THE FALLING DOLLAR, WHICH IS INFLATIONARY, HELPED COMMODITY PRICESADVANCE DURING 1990. A BOUNCE IN THE DOLLAR DURING MAY CONTRIBUTED TO THECRB PEAK THAT MONTH. COMMODITIES FIRMED AGAIN DURING THE SUMMER AS THEDOLLAR PROPPED TO NEW LOWS.
APPENDIX
265
FIGURE A.6THE U.S. DOLLAR VERSUS GOLD FROM LATE 1989 THROUGH SEPTEMBER 1990. THEDECLINING DOLLAR DURING MOST OF 1990 WASN'T ENOUGH TO TURN THE GOLD TRENDHIGHER. HOWEVER, THE INVERSE RELATIONSHIP CAN STILL BE SEEN, ESPECIALLY DURINGTHE DOLLAR SELLOFFS IN LATE 1989 AND JUNE 1990, WHEN GOLD RALLIED. THE INTERIMBOTTOM IN THE DOLLAR IN FEBRUARY 1990 WAS ENOUGH TO PUSH GOLD PRICES LOWER.
CRB Index
U.S. Dollar Index
Dollar Index
Gold
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FIGURE A.7GOLD VERSUS THE DOW INDUSTRIALS FROM THE SUMMER OF 1989 TO THE AUTUMN OF1990. THE GOLD RALLY IN THE FALL OF 1989 COINCIDED WITH STOCK MARKET WEAKNESS.THE FEBRUARY 1990 PEAK IN GOLD COINCIDED WITH A RALLY IN STOCKS. GOLD ROSEDURING THE SUMMER OF 1990 AS STOCKS WEAKENED. THROUGHOUT THE PERIOD SHOWN,GOLD DID BEST WHEN THE STOCK MARKET FALTERED.
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267
FIGURE A.8A COMPARISON OF AMERICAN, BRITISH, AND JAPANESE STOCK MARKETS IN THE 18-MONTHPERIOD ENDING IN THE THIRD QUARTER OF 1990. ALL THREE MARKETS DROPPED SHARPLYAT THE BEGINNING OF 1990 AND THEN RALLIED IN THE SPRING. NEITHER OF THE FOREIGNMARKETS CONFIRMED THE AMERICAN RALLY TO NEW HIGHS DURING THE SUMMER OF 1990.THE "TRIPLE TOP" IN BRITAIN AND THE COLLAPSE IN JAPAN HELD BEARISH IMPLICATIONSFOR AMERICAN EQUITIES. GLOBAL MARKETS THEN COLLAPSED TOGETHER.
Dow IndustrialsDow lndustrials-75 Weeks
FT-100
ColdNikkei 225
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FIGURE A.9AMERICAN VERSUS JAPANESE STOCK MARKETS FROM SEPTEMBER 1989 TO SEPTEMBER1990. BOTH MARKETS TURNED DOWN IN JANUARY. ALTHOUGH THE AMERICAN MARKETAPPEARED TO SHRUG OFF THE JAPANESE COLLAPSE DURING THE FIRST QUARTER OF 1990,THE SECOND FALL IN JAPAN DURING THE SUMMER TOOK ITS TOLL ON ALL GLOBALMARKETS. THE JAPANESE RALLY FROM MAY INTO JULY HELPED STABILIZE THE AMERICANMARKET. HOWEVER, THE AMERICAN RALLY TO NEW HIGHS WASN'T CONFIRMED BY THEJAPANESE MARKET, WHICH BARELY RETRACED HALF OF ITS PREVIOUS LOSSES.American versus Japanese Stocks
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269
FIGURE A.10A COMPARISON OF THE AMERICAN, BRITISH, GERMAN, AND JAPANESE BOND MARKETSDURING THE SUMMER OF 1990. GLOBAL BOND MARKETS TUMBLED AS OIL PRICES SURGEDFOLLOWING IRAQ'S INVASION OF KUWAIT ON AUGUST 2,1990. JAPANESE BONDS TURNEDIN THE WORST PERFORMANCE (OWING TO JAPAN'S GREATER DEPENDENCE ON OIL), NOTONLY LEADING GLOBAL BOND PRICES LOWER BUT ALSO ACCOUNTING FOR THE COLLAPSEOF JAPANESE EQUITIES.
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271
FIGURE A.11DOW INDUSTRIALS VERSUS CRUDE OIL DURING THE SUMMER OF 1990. THE INFLATIONARYIMPACT OF SURGING OIL PRICES DURING THE SUMMER OF 1990 TOOK A BEARISH TOLL ONEQUITY PRICES EVERYWHERE ON THE GLOBE. OIL BECAME THE DOMINANT COMMODITYDURING 1990 AND DEMONSTRATED HOW SENSITIVE BOND AND STOCK MARKETS ARE TOACTION IN THE COMMODITY SECTOR.Stocks versus Oil
FIGURE A.12CRUDE OIL VERSUS OIL STOCKS DURING 1990. OIL STOCKS HAD SPENT THE FIRST HALFOF 1990 IN A HOLDING PATTERN WHILE OIL PRICES WEAKENED. OIL STOCKS EXPLODED TONEW HIGHS IN EARLY JULY WHEN OIL BOTTOMED. AS THE THIRD QUARTER OF 1990 ENDED,HOWEVER, FALLING OIL SHARES HAVE SET UP A "NEGATIVE DIVERGENCE" WITH THE PRICEOF OIL, WHICH IS TESTING ITS ALL-TIME HIGH AT $40.Crude Oil versus Oil Stocks
GLOSSARY
Advance/Decline Line: One of the most widelyused indicators to measure the breadth of a stockmarket advance or decline. Each day (or week) thenumber of advancing issues is compared to the number of declining issues. If advances outnumber declines, the net total is added to the previous cumulative total. If declines outnumber advances, thenet difference is subtracted from the previous cumulative total. The advance/decline line is usuallycompared to a popular stock average such as theDow Jones Industrial Average. They should trendin the same direction. When the advance/declineline begins to diverge from the stock average, an earlyindication is given of a possible trend reversal.
down to the right below price troughs. Prices willoften meet resistance at rising channel lines andsupport at falling channel lines.
Arms Index: Also called Trin, this contrary indicator is the average volume of declining stocks divided by the average volume of advancing stocks. Areading below 1.0 indicates more volume in risingstocks. A reading above 1.0 reflects more volume indeclining issues. However, an extreme high readingsuggests an oversold market and an extreme lowreading, an overbought market.
Descending Triangle: A sideways price patternbetween two converging trendlines, in which theupper line is declining while the lower line is flat.This is generally a bearish pattern.
Ascending Triangle: A sideways price pattern between two converging trendlines, in which thelower line is rising while the upper line is flat.This is generally a bullish pattern.Bar Chart: The most common type of price chartused by market technicians. On a daily bar chart,each bar represents one day's activity. The vertical bar is drawn from the day's highest price to theday's lowest price (the range). A tic to the left of thebar marks the opening price, whereas a tic to theright of the bar marks the closing price. Bar chartscan be constructed for any time period, includingmonthly, weekly, hourly, and selected minute periods.Breakaway Gap: A price gap that forms on thecompletion of an important price pattern. A breakaway gap usually signals the beginning of an important price move.Bullish Consensus: Weekly numbers based on apoll of newsletter writers published by HadadyPublications in Pasadena, California. When 80 percent of newsletter writers are bullish on a market,that market is considered to be overbought and vulnerable to a price decline. Readings below 30 percent are indicative of an oversold market and areconsidered bullish.Channel Line: Straight lines drawn parallel to thebasic trendline. In an uptrend, the channel lineslants up to the right and is drawn above rallypeaks: in a downtrend, the channel line is drawn
Confirmation: Having as many technical factorsas possible agreeing with one another. For example, if prices and volume are rising together, volume is confirming the price action. The oppositeof confirmation is divergence.Continuation Patterns: Price formations that imply a pause or consolidation in the prevailingtrend, after which the prior trend is resumed. Themost common types are triangles, flags, and pennants.
Divergence: A situation where two indicators arenot confirming each other. For example, in oscillator analysis, prices trend higher while an oscillatorstarts to drop. Divergence usually warns of a trendreversal.Double Top: This price pattern displays twoprominent peaks. The reversal is complete whenthe middle trough is broken. The double bottom isa mirror image of the top.Down Trendline: A straight line drawn down andto the right above successive rally peaks in a downtrend. A violation of the down trendline usuallysignals a change in the trend.Dow Theory: One of the oldest and most highlyregarded of technical theories. A Dow Theory buysignal is given when the Dow Industrial and DowTransportation Averages close above a prior rallypeak. A sell signal is given when both averagesclose below a prior reaction low.Elliott Wave Analysis: An approach to marketanalysis that is based on repetitive wave patternsand the Fibonacci number sequence. An ideal Elliott Wave pattern shows a five-wave advance followed by a three-wave decline. The Fibonacci number sequence (1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144...) is constructed by adding the first two numbers to arrive at the third. The ratio of any numberto the next larger number is 62 percent, which isa popular Fibonacci retracement number. The inverse of 62 percent, which is 38 percent, is alsoused as a Fibonacci retracement number. The ratio of any number to the next smaller number is1.62 percent, which is used to arrive at Fibonacciprice targets. Elliott Wave Analysis incorporates
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GLOSSARY
the three elements of pattern (wave identification),ratio (Fibonacci ratios and projections), and time.Fibonacci time targets are arrived at by counting Fibonacci days, weeks, months, or years from prominent peaks and troughs.
then close below the previous day's closing price.In a downtrend, prices open lower and then closehigher. The wider the price range on the key reversal day and the heavier the volume, the greater theodds that a reversal is taking place.
Exhaustion Gap: A price gap that occurs at theend of an important trend and signals that the trendis ending.
Line Charts: Price charts that connect the closingprices of a given market over a span of time. Theresult is a curving line on the chart. This type ofchart is most useful with overlay or comparisoncharts that are commonly employed in intermarketanalysis.
Exponential Smoothing: A moving average thatuses all data points, but gives greater weight tomore recent price data.Flag: A continuation price pattern, generally lasting less than three weeks, which resembles a parallelogram that slopes against the prevailing trend.The flag represents a minor pause in a dynamicprice trend.Fundamental Analysis: The opposite of technicalanalysis. Fundamental analysis relies on economicsupply/demand information as opposed to marketactivity.Gaps: Gaps are spaces left on the bar chart whereno trading has taken place. An up gap is formedwhen the lowest price on a trading day is higherthan the highest high of the previous day. A downgap is formed when the highest price on a day islower than the lowest price of the prior day. An upgap is usually a sign of market strength, whereasa down gap is a sign of market weakness. Threetypes of gaps are breakaway, runaway (also calledmeasuring), and exhaustion gaps.Head and Shoulders: The best known of the reversal price patterns. At a market top, three prominent peaks are formed with the middle peak (orhead) slightly higher than the two other peaksshoulders). When the trendline (neckline) connecting the two intervening troughs is broken, thepattern is complete. A bottom pattern is a mirrorimage of a top and is called an inverse head andshoulders.Intermarket Analysis: An additional aspect oftechnical analysis that takes into consideration theprice action of related market sectors. The foursectors are currencies, commodities, bonds, andstocks. International markets are also included.This approach is based on the premise that all markets are interrelated and impact on one another.
Momentum: A technique used to construct anoverbought/oversold oscillator. Momentum measures price differences over a selected span of time.To construct a 10-day momentum line, the closingprice 10 days earlier is subtracted from the latestprice. The resulting positive or negative value isplotted above or below a zero line.Moving Average: A trend-following indicator thatworks best in a trending environment. Moving averages smooth out price action but operate witha time lag. A simple 10-day moving average of astock, for example, adds up the last 10 days' closing prices and divides the total by 10. This procedure is repeated each day. Any number of moving averages can be employed, with different timespans, to generate buy and sell signals. When onlyone average is employed, a buy signal is givenwhen the price closes above the average. When twoaverages are employed, a buy signal is given whenthe shorter average crosses above the longer average. Technicians use three types: simple, weighted,and exponentially smoothed averages.Open Interest: The number of options or futurescontracts that are still unliquidated at the end of atrading day. A rise or fall in open interest showsthat money is flowing into or out of a futurescontract or option, respectively. Open interest alsomeasures liquidity.Oscillators: Technical indicators that are utilizedto determine when a market is in an overboughtand oversold condition. Oscillators are plotted atthe bottom of a price chart. When the oscillator reaches an upper extreme, the market is overbought. When the oscillator line reaches a lowerextreme, the market is oversold. Two types of oscillators use momentum and rates of change.Overbought: A term usually used in reference toan oscillator. When an oscillator reaches an upperextreme, it is believed that a market has risen toofar and is vulnerable to a selloff.
Island Reversal: A combination of an exhaustiongap in one direction and a breakaway gap in theother direction within a few days. Toward the endof an uptrend, for example, prices gap upward andthen downward within a few days. The result isusually two or three trading days standing alonewith gaps on either side. The island reversal usually signals a trend reversal.
Oversold: A term usually used in reference to anoscillator. When an oscillator reaches a lower extreme, it is believed that market has dropped toofar and is due for a bounce.
Key Reversal Day: In an uptrend, this one-daypattern occurs when prices open in new highs and
Pennant: This continuation price pattern is similar to the flag, except that it is more horizontal and
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GLOSSARYresembles a small symmetrical triangle. Like theflag, the pennant usually lasts from one to threeweeks and is typically followed by a resumptionof the prior trend.% Investment Advisors Bullish: This measureof stock market bullish sentiment is publishedweekly by Investor's Intelligence in New Rochelle,New York. When only 35 percent of professionals are bullish, the market is considered oversold.A reading of 55 percent is considered to be overbought.Price Patterns: Patterns that appear on pricecharts that have predictive value. Patterns are divided into reversal patterns and continuation patterns.Put/Call Ratio: The ratio of volume in put optionsdivided by the volume of call options is used as acontrary indicator. When put buying gets too highrelative to call buying (a high put/call ratio), themarket is oversold. A low put/call ratio representsan overbought market condition.Rate of Change: A technique used to construct anoverbought/oversold oscillator. Rate of change employs a price ratio over a selected span of time. Toconstruct a ten-day Rate of Change oscillator, thelast closing price is divided by the close price tendays earlier. The resulting value is plotted aboveor below a value of 100.Ratio Analysis: The use of a ratio to compare therelative strength between two entities. An individual stock or industry group divided by the S&P 500index can determine whether that stock or industry group is outperforming or underperforming thestock market as a whole. Ratio analysis can be usedto compare any two entities. A rising ratio indicatesthat the numerator in the ratio is outperformingthe denominator. Ratio analysis can also be usedto compare market sectors such as the bond market to the stock market or commodities to bonds.Technical analysis can be applied to the ratio lineitself to determine important turning points.Relative-Strength Index (RSI): A popular oscillator developed by Welles Wilder, Jr., and describedin his 1978 book, New Concepts in Technical Trading Systems. RSI is plotted on a vertical scale from0 to 100. Values above 75 are considered to be overbought and values below 25, oversold. When pricesare over 75 or below 25 and diverge from price action, a warning is given of a possible trend reversal.RSI usually employs time spans of 9 or 14 days.Resistance: The opposite of support. Resistanceis marked by a previous price peak and providesenough of a barrier above the market to halt a priceadvance.Retracements: Prices normally retrace the priortrend by a percentage amount before resuming theoriginal trend. The best known example is the 50
percent retracement. Minimum and maximum retracements are normally one-third and two-thirds,respectively. Elliott Wave Theory uses Fibonacciretracements of 38 percent and 62 percent.Reversal Patterns: Price patterns on a price chartthat usually indicate that a trend reversal is takingplace. The best known of the reversal patterns arethe head and shoulders and double and triple topsand bottoms.Runaway Gap: A price gap that usually occursaround the midpoint of an important market trend.For this reason, it is also called a measuring gap.Saucer: A price reversal pattern that represents avery slow and gradual shift in trend direction.Sentiment Indicators: Psychological indicatorsthat attempt to measure the degree of bullishnessor bearishness in the stock market or in individual markets. These are contrary indicators and areused in much the same fashion as overbought oroversold oscillators. Their greatest value is whenthey reach upper or lower extremes.Simple Average: A moving average that givesequal weight to each day's price data.Stochastics: An overbought/oversold oscillatorthat is based on the principle that as prices advance, the closing price moves to the upper end ofits range. In a downtrend, closing prices usually appear near the bottom of their recent range. Time periods of 9 and 14 days are usually employed in itsconstruction. Stochastics uses two lines—%K andits 3-day moving average, %D. These two lines fluctuate in a vertical range between 0 and 100. Readings above 80 are overbought, while readings below20 are oversold. When the faster %K line crossesabove the slower %D line and the lines are below20, a buy signal is given. When the %K crosses below the %D line and the lines are over 80, a sellsignal is given. There are two stochastics versions:fast stochastics and slow stochastics. Most tradersuse the slower version because of its smootherlook and more reliable signals. The formula for fasfstochastics is:
In the formula, n usually refers to the number ofdays, but can also mean months, weeks, or hours.The formula for stow stochastics is:slow %K = fast %Dslow %D = 3 day average of fast %D.Support: A price, or price zone, beneath the current market price, where buying power is sufficient
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GLOSSARY
to halt a price decline. A previous reaction lowusually forms a support level.
current trend. The breaking of a trendline usuallysignals a trend change.
Symmetrical Triangle: A sideways price patternbetween two converging trendlines in which theupper trendline is declining and lower trendlineis rising. This pattern represents an even balancebetween buyers and sellers, although the priortrend is usually resumed. The breakout througheither trendline signals the direction of the pricetrend.
Triangles: Sideways price patterns in whichprices fluctuate within converging trendlines. Thethree types of triangles are the symmetrical, the ascending, and the descending.
Technical Analysis: The study of market action,usually with price charts, which also includes volume and open interest patterns.
Triple Top: A price pattern with three prominentpeaks, similar to the head and shoulders top, except that all three peaks occur at about the samelevel. The triple bottom is a mirror image of thetop.
Trend: Refers to the direction of prices. Rising peaks and troughs constitute an uptrend;falling peaks and troughs constitute a downtrend.A trading range is characterized by horizontalpeaks and troughs. Trends are generally classifiedinto major (longer than six months), intermediate (one to six months), or minor (less than amonth).
Up Trendline: A straight line drawn upward andto the right below reaction lows in an uptrend. Thelonger the up trendline has been in effect and themore times it has been tested, the more significantit becomes. Violation of the trendline usually signals that the uptrend may be changing direction.Volume: The level of trading activity in a stock,option, or futures contract. Expanding volume inthe direction of the current price trend confirmsthe price trend.
Trendlines: Straight lines drawn on a chart belowreaction lows in an uptrend, or above rally peaksin a downtrend, that determine the steepness of the
Weighted Average: A moving average that uses aselected time span but gives greater weight to morerecent price data.
Index
Advance/decline line, 3, 273Aluminum shares, 171, 172Angell, Wayne, 116, 117, 146Arms Index, 273Ascending triangle, 273, 276Asset allocation, 11, 226role of commodities in, 206, 207,220-221, 223-224role of futures in, 216-217Asset Allocation Review, 226, 228, 234
Bullish consensus, 273Business Conditions Digest, 231Business cycle, 11, 19, 225-239bonds and, 54, 229-230chronological sequences of bonds, stocks,and commodities in, 226—227commodities in, 228long- and short-leading indexes, 230-231six stages of, 228-229stocks and commodities as leadingindicators of, 232-235
Baker, James, 116Bank stocks, 149, 164Bar chart, 41, 42, 273Bond(s):and commodities, 9, 10, 13, 24, 28and the CRB Index, 24-30and the dollar, 54, 58, 59in economic forecasting, 229-230global, 141-143as a leading indicator of stocks, 43-51prices vs. yields, 21, 24, 139vs. savings and loan stocks, 165-168vs. stocks, 9, 15, 40-55, 262and utilities, 178-181Bond market(s):bottom of 1981, 41-43collapse of, 13, 14-17, 24comparison of, 140, 273short-term interest rates and, 52Bond-stock link:financial markets on the defensive, 40-41long lead times, 51role of business cycle in, 54Breakaway gap, 273, 274
Canada, 142Center for International Business CycleResearch (CIBCR), 99, 230Channel line, 273Chernobyl accident, 14Chicago Mercantile Exchange, 7Closing prices, 274Commodities:basket approach to, 220, 222, 224bonds and, 9, 10, 13and the dollar, 9, 56-57, 75and Federal Reserve policy, 116-117and interest rates, 13, 22, 38as the missing link in intermarketanalysis, 255-256ranking individual, 200-203vs. stocks, 90-91Commodity-bond link:and the dollar, 75economic background of, 22how technical analysts use, 30-34, 229importance of T-bill action, 36-38inflation as the key to, 20-21277
278
market history in the 1980s, 22-24relative-strength analysis in, 35, 200-203,205since 1987, 24-30role of short-term rates, 35-36vs. stocks, 90-91technical analysis of, 34-35Commodity futures, as an asset class, 11,220-221, 223, 224Commodity groups, 9, 97-98, 188-191Commodity indexes, 95-121energy vs. metals markets, 113-114grains, metals, and oils, 98industrials vs. foodstuffs, 99, 100-101,102interest rates vs., 106-108intermarket roles of gold and oil, 114—115metals and energy futures vs. interestrates, 115-116visual comparisons of, 100Commodity markets, 8Commodity prices, 12, 24, 27, 56-57, 96compared to bond prices, 207as a key to inflation, 3, 20-21, 57-59, 60Commodity Research Bureau, 22, 95Commodity Research Bureau (CRB) FuturesGroup Indexes, 95, 109-110, 188Commodity Research Bureau (CRB) FuturesPrice Index, 4-5, 7, 8, 12, 20, 95applications of, 186, 220, 226a balanced picture of, 108-109and the bond market, 5, 9, 13, 24-30,216vs. bonds and utilities, 181-184construction of, 22, 96-97vs. the CRB spot index, 98-99, 103, 121descending triangle in, 33, 34dollar and, 59-62, 70-72, 264and the Dow Jones Industrial Average,233gold and, 68-70, 71, 265vs. grains, metals, and energy groups, 9,110-113group correlation studies of, 97-98and interest rates, 120vs. the Journal of Commerce (JOC) Index,104-106, 121vs. the Producer Price Index andConsumer Price Index, 117-120vs. savings and loans, 168-169vs. stocks, 5, 211-216, 217and Treasury bills, 35, 36-38and Treasury bonds, 10, 13, 21, 22-30,31, 32, 34, 35, 36, 38-39, 107, 109, 150,207-211, 261
INDEX
Commodity Research Bureau {CRB} SpotIndex, 95, 98-99, 234Computerization, 53, 256-257Confirmation, 31, 43, 147, 161, 186, 204,273Consumer Price Index (CPI), 9, 20, 35, 96,117-120, 121, 222Consumer Price Index for Urban WageEarners and Clerical Workers (CPI-W),117Continuation patterns, 14, 273, 275Contraction, 10, 225, 226, 229Copper, 171, 172, 226as an economic indicator, 235—237and the stock market, 237-238, 239CRB Index, see Commodity Research BureauFutures Price IndexCRB Index Futures Reference Guide, 39,97CRB Index White Paper, 38, 118Cullity, John P., 232Depression, 48, 225Descending triangle, 33, 34, 273, 276Deutsche mark, 66, 69, 70, 71, 217Discount rate, 52Disinflation, 21, 23Divergence, 15, 32, 43, 45, 51, 67, 69, 147,161, 164, 167, 180, 186, 204, 273Diversification, 215, 222Dollar, U.S.:.and commodity prices, 56-57, 75vs. the CRB Index, 59-62, 70-72, 264foreign currencies and, 66gold market and, 60, 63-65, 73, 25