Market rallies appropriately have been compared to the launch of a rocket. For a rocket to have enough momentum to exit the Earth’s atmosphere, the ship must be launched with enough initial force to overpower Earth’s gravity and penetrate the planet’s atmospheric constraints.
Market thrust theory portends the market has an atmosphere of boundaries as well, made up of old trading ranges, resistance lines and the tendency of investors to submit to the urge to pocket short-term profits.
If a market move is to have a chance of overcoming these boundaries, the initial rally must be propelled with a thrust adequate in force to send the market through levels of resistance that thwarted previous rally-launching attempts.
In thrust we trust
In his book "Winning on Wall Street," published in the mid-1980s, Martin Zweig detailed a particular breadth thrust signal that occurred on rare occasions where the sum of daily advancing issues over any 10-day period was twice the sum of declining issues on the New York Stock Exchange Composite Index. For an updated table, see "Traditional breadth thrust signals" (below).
After more than a decade (1992-2008) without a lot of guidance from traditional market breadth thrust indicators, such as Zweig’s 10-day, two-to-one NYSE Advance/Decline Ratio Signal, there were three sightings in 2009 that generated a renewed interest in understanding these signals’ historical significance.
The genesis of more recent thrust research came in the fall of 2009 when it was discovered that the signals described here are one of the more reliable intermediate-term equity index signals in existence. This does not mean the indicator doesn’t miss opportunities, however. You may have observed that the signals went AWOL during the 1990s — a decade in which the S&P tripled. Nevertheless, the signals are too statistically significant to ignore when they do trigger.
Because of their rare occurrence, these signals can’t be traded alone. You’ll need something to trade if they go through another silent decade. After additional thrust research, it became evident there are other market internals besides 10-day breadth that can be utilized to measure the market’s potential for launching equity prices from point A to point B. My initial research in this area was summarized in a research paper titled "Planes, Trains and Automobiles (PTA)." It was recognized by the Market Technicians Association (MTA) with the 2010 Charles Dow Award and is outlined in the following five steps:
- Revisit the significance of breadth (advance/decline) thrust in launching major market moves.
- Evaluate the utility of evaluating market momentum via measures other than breadth.
- Study the statistical significance of reverse thrust, commonly referred to as capitulation.
- Study the significance of lack of thrust signal sightings over extended periods.
- Combine all the above research into an intermediate-time frame trading model.
Measuring market momentum
The approach was to revisit thrust research starting from square one. The effort evaluated as many measures of market momentum as possible over time periods from one to 63 days and identified those that were highly reliable in signaling intermediate (three- to 12-month) moves in the S&P 500. Techniques studied included breadth (advances vs. declines), up vs. down volume, price change, Trin (volume in advancing vs. declining issues), number of issues making 12-month highs and 12-month lows.
Most of the indicators studied did not prove to be viable, but much was learned in the process, and it helped provide the basis for the thrust model known as the PTA tape model (referred to as PTA7, for being the seventh version).
PTA7 breadth thrust model
The PTA7 model utilizes thrust signals from various sources. We will address the new version of the breadth thrust component implemented. The cumulative advance/decline line on the NYSE is the traditional measure of market breadth. It customarily is used because it yields a broad measure of the number of predominantly Blue Chip issues participating in either upward or downward moves. Similar analysis could and has been performed successfully with other indexes as well as derivations of the NYSE Composite.
Since Zweig published "Winning on Wall Street" in the mid-1980s, the NYSE has become increasingly polluted with non-equity issues, such as bond funds. Most research firms have moved to equity-only indexes for tape analysis. This author’s current research in this area uses tape data on the equity-only S&P 500 index.
The breadth measure incorporated here is simply the percent of daily advances over an n-day period as a percentage of both advances and declines (or issues traded minus unchanged) during the same period of interest,
ADTN = 100 * SUMADV / (SUMADV + SUMDEC)
where SUMADV is the sum of daily advances over n days.
As an example, for a 10-day period where advancing issues lead declining issues by a two-to-one ratio, we would generate an ADT10 of 66.66.
This seems like a logical equation for this type of analysis. It also has been referred to as a Zweig Thrust Measure. When using the S&P data set, all time frames from one to 21 days result in some degree of statistically significant breadth thrust at certain high and low levels of measurement. "One-year results" (below) includes a breakdown of the forward one-year performance for all days since 1970 as a function of the ADT10 level.
The category above 65, which was similar to the two-to-one ratio on the original thrust measurement, was up 91% of the time one year later for an average 14.33% return. Note that low levels are bullish, as well.
The approach on this iteration of PTA7 was to turn the computer loose on thrust measurements. It studied not only different time frames but combinations of different time frames. Based on measurements of intermediate market performance, which took into consideration three-, six- and 12-month average and median performance and the numbers of signals generated, the study stumbled onto an optimum breadth thrust indicator.
A PTA7 breadth thrust occurs when: 1) you get an ADT3 of 79.5 or higher, that 2) was preceded in the previous three days by an ADT2 of at least 84.50. This test was performed on S&P 500 tape data going back to 1970. This combination of two measurements has resulted in the 27 tape signals shown in "PTA7 breadth thrust signals" (below).
The genesis of this research concerned the absence of signals on the original two-to-one NYSE system during the bull market of the 1990s. The PTA7 breadth model produced four signals during that decade. These additional signals were achieved with comparable signal performance to the original two-to-one thrust signal. Note that the median one-year return of 23.21% on the 27 PTA7 signals had three signals still in play as of March 30. After all 27 signals, the S&P 500 was higher either six or 12 months later.
As we alluded, PTA7 gains insight into the tape’s health from an evaluation of price and volume, but also evaluates reverse thrust conditions, lack of thrust conditions and periods with characteristics contrary to thrust environments (confused markets), along with some trend-following safeguards. While the PTA7 system’s signal infrequency may make it somewhat passive for some traders, this same attribute, when paired with its accuracy, makes it an excellent addition to a larger collection of analysis tools and systems.
Wayne Whaley holds a systems engineering degree from Georgia Tech and takes an engineering approach to tape analysis. He is a registered commodity trading advisor (CTA), co-owner of Witter & Lester and the 2010 MTA Charles Dow Award winner for research surveying various tape measures. For more insight see www.witterlester.com.