Hi EK, Re: v-Wave particulars....................
Those are some interesting observations. The history of the indexes may just be a peculiarity of the time frame shown. The SPY seems to be the slower reacting and least volatile of the three indexes shown. I guess that makes some sense since the N-Comp tends to be more volatile and the Dow is only 30 companies instead of 500. Even so, it would be interesting to see a deeper history than that shown. They are all currently normalized to the starting date and nothing more. That means the playing field needed to be level at that time which may or may not be the case.
I have planned to gather more data going back, I hope, to the beginning of the decade. The larger public libraries keep Value Line on hand for many years and that is where I plan on doing my data mining.
Yes, there's some delay in the Value Line data relative to the marketplace. Although they report weekly, there appears to be about a week's delay beyond that. I usually assume the v-Wave is a week to two weeks out of phase. So, it's probably better used as a longer term indicator than something that a "day trader" might use. The Value Line "Appreciation Potential" is published weekly had tracks inversely to the market's moves. That's why the v-wave was structured the way it is. Value Line shows for this week, "The estimated median price appreciation potential of all 1700 stocks in the hypothesized economic environment 3 to 5 years hence = 70%; 26 weeks ago = 45%; Market Low = 115% 10-9-02; Market High = 35% 7-13-07"
There was another indicator that I created many years ago called the i-Wave. I used it in conjunction with a portfolio asset allocation method called AIM. In AIM one balances Equity with Cash over time. As the equity side rises in value, some is sold and moved to the cash side for safe keeping. During market declines when the equity value is dropping, the cash is used to build out the equity position at discounted prices.
The v-Wave's "bullish" and "bearish" designations correlate to the AIM program's Equity/Cash ratio. If the program got you to the the point the account was 50% cash, then you'd sold a lot of equity and it usually corresponded to market tops. Therefore around that level was "bearish" going forward.
At the other extreme, when the program had drawn down cash reserves to less than 30% of total, generally that occurred near market lows when we want to be more fully invested. My history showed that 80% of the time the cash levels were between 30% and 50% and therefore "neutral." Ten percent of the time the cash levels were either below 30% or above 50%. These extremes of the bell curve, then are the bullish and bearish ends.
Looking at it another way, 90% of the time the program had a lower cash level than the bearish signal and this compared favorably to market risk. Only 10% of the time (since 1982 for the i-Wave) had the indicator shown a need for cash in the bullish range. So, if the range showed 45% cash as an indication, then we can assume that it is at the riskier end of the range. 40% is about dead center of the bell curve. Should this newer v-Wave show 5% or 10%, we would be very close to the bell curve bullish extremes.
Once I've gathered a deeper data base, I'll be able to refine the Bullish and Bearish territories in a similar fashion to the i-Wave. I'll still be looking at a 10/80/10 bell curve as the range. When we have a reading in the neutral range, we can only infer from a rising or falling trend if risk is rising or falling.
A difference between the older i-Wave and the new v-Wave is that the newer indicator can actually go to "negative" numbers. In other words, it could show during very deep bear markets that one only needed a minus 10% cash (or you could be 110% invested using 10% margin). The older i-Wave design made nearly impossible for it to indicate anything near zero and certainly never less than zero. Looking back to Value Line's "market low" reading of 115% appreciation potential that would in v-Wave terms mean being 115% invested or carrying 15% on margin. Corresponding to the market high of last summer, it was suggesting that we have just 35% invested and 65% in cash.
The older indicator also moved in +or-1 point increments so was a bit more finely tuned. The newer v-Wave moves in 5% increments because of the way Value Line reports their information.
With a deeper data base I'll be able to do some standard deviation calcs and come up with a better indication. Neutral, mildly oversold, oversold and extremely oversold and visa versa should be possible. I'll make sure to report when this next phase is done.
The ValuWave designation of cash is an expression of the "cash" side of an equity/cash ratio. So, if it shows 30% cash it also means 70% invested.
The v-Wave is probably reactive rather than predictive. It shows a measure of market risk vs appreciation potential. It makes a judgment as to how much of one's portfolio should be invested and how much should be held back in reserve for better valued markets. It would be appropriate to sell into market rallies if we see the v-Wave risk level rising.
Think of it as putting an upper risk limit on your portfolio. Let's say you don't want the value at risk in the market to be more than $100K. Then if the market value goes up to 110K, maybe it would make sense to sell 10K to get the level at risk back down to just 100K. If we saw a relatively benign "risk" indication on the v-Wave, or even a low risk designation, maybe we'd delay that rebalancing of equity and cash.
The reverse would also hold. If our hypothetical $100K at risk in the market dropped in value to $80K we could use the cash reserves to build out the portfolio back toward $100K. We'd be doing it when prices were low. If the v-Wave was showing a lower risk profile, we could have greater comfort in shifting the equity/cash ratio toward heavier equity participation.
I guess the red flags would be flying if we saw high risk and the value of our portfolio heading downward rapidly. Then we might wait for a lower risk designation by the v-Wave before shifting to a heavier equity position.
It's going to be interesting to see if the nice correlation to market risk continues. I've sampled Value Line's "Appreciation Potential" data back as far as the '80s and it looks like it is going to be very good. However, I don't have complete data for that time frame.
Best regards, Tom
PS: If you know anyone else that might have interest in this type of market risk indicator, please feel free to invite them to participate. Value Line has been a steady and reliable source of data and that's why I chose it for this indicator. |
