Building a viable indicator is only half the battle. The real trick is in applying that indicator profitably to the markets. The history of stock market trading is filled with forgotten treatises that designed analysis tools that worked great on paper but — whether because of logistics, faulty premises or the failed logic of their practitioners — blew up marvelously when used in real time in real markets.
In the first part of this series, we discussed advance-decline (A-D) analysis and showed how an A-D line based on the 20 Most Actives (MAAD) theoretically is superior to the more popular New York Stock Exchange A-D (NYAD) line. We explained the development of MAAD and identified key considerations and assumptions necessary in its construction. We also showed how it performed anecdotally.
Here, we will extend our assessment of its application by developing a system based on MAAD and testing it.
After weekly Most Actives and NYSE A-D data are collected and calculated, an algorithm extracts the highest and lowest monthly values from MAAD and NYAD. Exponential moving averages of “n” bars are applied to the highs and lows of the S&P 500, MAAD and NYAD to create moving average channels. A Slow K stochastics indicator based on MAAD or NYAD confirms buy and sell signals. The strategy rules are as follows:
- To generate a buy signal, the monthly high of the S&P 500 must rise above the upper line of the exponential moving average channel of the S&P 500 highs; the monthly high of MAAD or NYAD must rise above the upper line of the exponential moving average channel highs of MAAD or NYAD; and Slow K applied to MAAD or NYAD must rise above 0.50.
- To generate a sell signal, the monthly low of the S&P 500 must decline below the lower line of the exponential moving average channel of the S&P 500 lows; the monthly low of MAAD or NYAD must decline below the lower line of the exponential Moving Average Channel lows of MAAD or NYAD; and Slow K applied to MAAD or NYAD must decline below 0.50.
The Tradestation code for the above system is shown in “Coding the system” (below).