Custom indicator construction for the market minded.

Here you will find an ongoing application of custom indicator constructs for the technically oriented.  All who are interested in the stock market, technical analysis and the development of stock charts should consider following this webpage.  In particular we offer the Trip I.

Description of the Trip I

The three indicator curves, I1, I2 and I3, discussed below are based on the Hodrik-Prescott smoothing function applied to the logarithm of the original series–here, the NDX. The smoothing weight of the smoothing function in the first graph is 12 and the smoothing weight used in the second graph is 800.  These two weights are used throughout the postings found under The Scribbler.  

The Hodrick-Prescott smoothing function  is two sided which means that it uses future data as well as past data about any point to calculate the value of the function at a given point.  This means that the graph presentation becomes self correcting as time moves forward away from the current moment.  Unlike one sided smoothing functions which never correct false moves and where presentation of historical data always appears noisy or jerky, the Holdrick-Prescott function smooths away past error allowing a clearer view of trend behavior.  Turning behavior is clearly delineated using updates from future data.

For some this is considered a disadvantage in trading for suddenly an apparent change of direction which appears in the graph and on which the trader has committed or is planning to commit will be suddenly swept away.  However, this is also a clear warning that the trade or proposed trade may be at risk or faulty.  One that is hard to ignore and can induce useful caution when considering action.  This writer hopes that the reader will see the usefulness of this approach after following the postings at The Scribbler for awhile.

Short Term Trip I

To the left is an example of the short term Trip I panel reported in the postings.  The HP smoothing function in the short term panel   employs a weight of 12.  You will see the three indicators applied to the NASDAQ 100 (NDX) and labeled I1, I2 and I3.  They are called the Trip I for the three components shown.  The Hodrick-Prescott smoothed trend is labeled I1 in the graph.  The curve I2 is I1 plus a multiple of its difference, and the curve I3 is I2 with an added term derived from the Riemann curvature.

The two bands around I1 labeled I1u and I1d are a confidence measure of the trend.  When the I2 curve is within the bands the trend is potentially near a reversal. However, so long as the I2 does not cross I1 the trend will continue in the same direction.

When I2 is equal to I3 the smoothing curve is linear, variation about trend is minimal, and trending behavior is dominant.  When I1 = I2 the smoothed series I1 is flat implying a maximum or minimum.  When I1 = I2 = I3 the smoothed series I1 is at an inflection point.  A great deal of information about the underlying trend is contained in this graph.

At point A above I2 is close to I3 which implies that the trend direction is dominant.  Similarly, I2 is close to I3 at point B and in its vicinity.  However near B there is a crossing of I1 by I2 indicating a change in trend direction. When all three lines are within the bands, I1u and I1d, but with no crossing of I1 as at C, the price series will still trend in the same direction.  Sharp changes in direction are to be expected if I3 is outside the bands when I2 crosses I1 as at D.

Intermediate Trip I

The graph below is an example of the panel containing the intermediate Trip I which can be found in the postings.  It employs a smoothing weight of 800 and as can be seen produces a much smoother trend than the short term Trip I.  However, over the short period it does not demonstrate so many features as the short term Trip I.

To the left we can see three points labeled A at which the I2 and I3 curves are very close. When I2 = I3 the trend I1 is linear in form. When I2 moves away from I3 the trend will show curvature.  The greater the difference the greater the curvature of the I1 trend.  At D notice that when I2 crosses I1 at the maximum the I3 curve is outside the confidence bands. This is an indication that the crossing is a maximum and not an inflection.  To the right of the point D a true inflection can be seen.  Note that the I1 = I2 = I3 at the inflection point but the inflection is not easily observed even in retrospect when one examines the actual price history.

For an opportunity to see the Trip I in action visit The Scribbler.