The Hurst Trader

The South African market is represented by the All-Share Index, or ALSI in much the same way as the US market is represented by the S&P 500, and by the DJIA (Dow Jones Industrial Average). I have been keeping an eye on things with my TT software, and thought I would offer up some thoughts, and invite some discussion about the SA market and where it’s going.

The Big Picture

As this chart shows, the SA market has been in the grip of a roaring bull for the past 5 years. In fact it shows signs of being a pseudotrend, but that will have to be a discussion for another time (a pseudotrend is a strong move that is bolstered by fundamental interaction – in this case I suspect the Rand/Dollar exchange rate might have a lot to do with it). Things started to falter in October last year, but recovered from January to May this year (see this post). Since then it’s been tumbling. While we’re looking at the big picture – the 54 month (4 1/2 year) cycle is fairly clearly discernable, with a trough in late 1998, and another in mid 2003. (I haven’t shown the cycle phasing on this graph because by the time I scale the picture down for the web, the phasing is little more than a smudge). It is possible that the trough of January this year was another trough of this cycle, but the software chooses instead to say that trough still lies ahead of us, and indicates that the cycle (due to the Principle of Variation) is currently running long at 61.3 months). Time will tell whether this is in fact correct. If it is we could be in for some tumultuous downside action (the move down to the trough of a longterm cycle is often fairly dramatic). If it is not correct, and the cycle did form a trough in January this year then we should instead see some good upward action!

How does the software deal with this “alternative” scenario? It’s early days yet, but as time passes and it re-evaluates the phasing analysis, it should be alert to changes in the underlying trends of cycles. Time will tell, but that’s what this website is all about …

Software Prediction

Bottom line – the software indicates that the market is coming down into a 20-week nest-of-lows, expected anytime from about yesterday to about 3 weeks from now. Notice the 10 day and 5 day cycles are both overdue, but this is not a reason to say the market “isn’t turning yet” – coming into a big nest-of-lows the shorter cycles are often completely squashed by the heavy pressure of the longer term cycles, so we might not see any clear 5 or 10 day troughs before the big 20-week trough. From here the software is predicting a move up – all the way up to about 34000, which is interesting because if the market really is this late in the 61 month cycle, we shouldn’t be seeing another higher peak – however the software does include Sigma L (the sum of all cycles longer than the software can determine, which includes all possible pseudotrend), and so it is possible. It will be interesting to see if the market really does get up there. The lower level of the target zone is about 32000, which itself would be a higher peak.

The Recent Past

Now looking in much more detail at the move down since the end of May. There are 5 points of interest that I’ve highlighted:

• Price is currently at the mid-channel-pause level of the 18-month cycle, indicated by the fact that price is almost touching the 18-month FLD (the very thin yellow line which can be seen best to the left of the green BUY zone box). Price could cross this line without it having much significance, but it does indicate that price has reached a mid-channel reversal point.
• Price has come right down to touch the 18 month VTL. This fact isn’t greatly significant of itself – but if price manages to stay above the VTL, it is an indication that we haven’t yet seen the 54-month peak – so the chances are better of us getting a higher high (as the target mentioned above suggests). If price crosses below this VTL decidedly, then that would indicate that we have seen the peak of the 54-month cycle, and the chances of the market reaching a higher high are smaller. It wouldn’t remove the chance of there being an upward move at this point, but it would LOWER the target somewhat. Of course the 18-month VTL would be in a different place if the “alternate” mentioned above was true – that we have seen the 54-month trough back in January.
• The 20-week nest-of-lows is due now as mentioned earlier. Note that if the phasing analysis is not quite correct, this could in fact be a stronger nest-of-lows than 20-weeks – which doesn’t change our outlook, it’s really just an interesting point.
• Action signals are well above price. The action signals I’m talking about here are the signals that would indicate that the nest-of-lows has occurred (yesterday for instance). The shortest action signal that would have any meaning at the moment is the 20-day cycle VTL or FLD. Both are well above price, so I would certainly not be about to start buying just yet. But next week the 20-day FLD drops fairly sharply, and I expect that next week I’m going to be standing-by to identify the 20-week trough.

Another small point of interest: Elliott wave fans might be able to count a fairly clear a-b-c 3-wave correction, which is an indication of how Elliott and cyclic analysis although taking slightly different approaches often indicate the same results.

As I build this website I am gradually adding to the glossary, which explains some of the more technical terms. If there’s something that confuses you, that hasn’t made it into the glossary, or if you are interested in this sort of analysis, and would like to discuss it, or would like me to consider a particular share of interest to you, please let me know by adding a comment to this post, or by email: david@sentientcode.com.

The means by which cyclic concepts are used to produce transaction-decision information. – JM Hurst

Well that’s what it’s all about, isn’t it? Cyclic Analysis is based (fairly obviously) on the cyclic concepts Hurst mentions. In other words, it is the analysis of stock market price movement, assuming the validity of cyclic theory.

Phasing Analysis is a procedure for isolating the wave components (cycles) present in a complex, composite wave (the price of a tradable entity). It consists of a series of methods whereby wave trough positions are estimated. – JM Hurst

I sometimes refer to phasing analysis as cycle phasing. It is basically an analysis process performed by the software to generate a current cyclic model – a model that defines the wavelength and phase of all cycles between 5 days and 18 years currently active in the market price data.

As a result of phasing analysis the software is able to speculate as to when the troughs and peaks of various cycles are likely to occur.

Detailed summary of the ALSI trade presented on the home page:

The software indicates that the 46.1 week cycle formed a trough a week ago, on the 22nd of January. This is the nominal 9 month cycle, so we can now expect 2 x 20-week cycles, with the peak of the next 9-month cycle most likely occurring in the FIRST of these sub-cycles because the short-term underlying trend of the 9 month cycle is DOWN (18-month turning down, 54-month down). This is therefore a good time to buy as we expect a 9-month magnitude peak within the next 20 weeks (the software targets the 25th of April). The target for a long trade is given as 30500 (the middle of the red sell-zone on the chart), and the expected exit date for the trade is between mid-April and late-May. The stoploss level is set a small distance below the most recent low (of 21932) at 21750. Between here and the target there are two Pause Zones (the sandy coloured background boxes), so the price is likely to pause in those areas on its way to the target. There are several FLD’s in cascade position, which will project price upwards.

This gives us the following buy situation, which indicates a Potential to Risk ratio of 2 at a price of 24666. I would prefer a higher PR ratio (of 3 – 3 1/2), but given the high confidence rating of the phasing at this point (not shown), and the extreme nature of the recent trough indicating probable fundamental interaction on the day of 22nd January – which is a typical “panic bottom” occurrence – also called a spike, or key-reversal day, (note that day’s candle’s long lower tail, or shadow) – I will go ahead with the trade, particularly as the gross% profit to be made is very satisfactory at over 300%.

The thing now is to find an entry action signal. Given the high confidence rating of the cycle phasing, I look for an action signal that would confirm the recent nest-of-lows. A 10 day VTL has already occurred – Friday last week, which increases my confidence, however a longer cycle confirmation would be better. Given that the recent 20-day troughs have been well-spaced, a 20-day confirmation would be good enough – but the 20-day VTL is too high to provide an effective entry, and so I choose the 20-day FLD, and use the FLD high as opposed to the FLD median because the high gives me an instant action signal (in fact the difference between the two is not great at this point, and the entry level is not much changed by this decision). The 20-day FLD high was at 24000 today, below yesterday’s high of 24195 – and so I choose 24200 as an entry level (requiring that price exceed yesterday’s high). Referring back to the buy situation table, this gives a PR ratio of about 2 1/2. I’ve highlighted the 20-day FLD high in yellow in the chart below (I know there are lots of lines and colours … it confuses me too!)

In fact the entry occurs fairly near the high of the day, and the trading for the day closes slightly below my entry, but there is no cause for alarm!

The trade progresses very well, with all the cyclic events falling into place as expected, including a pause/correction in the pause zone identified between 26000 and 27000 – which because it was expected gave no cause for alarm. We’ll jump forward now to the 28th of May. The software two days ago identified the peak of the 20-week cycle (which is the cycle we are trading) as having occurred on the 22nd of May. It is now projecting DOWN to a new target somewhere below 27000.

If we had exited at our original target of 30500 (assuming that no better-than-expected signal had been received), then our exit would have been effected on the 14th of May, however assuming that we canceled that exit (ignoring the software, and hoping for more upside), an action signal at the crossing of the 80-day VTL (confirming the 20-week peak) would have taken us out on the 28th of May at 30200.

This trade would have been a profitable one:

Margin Deposit: R18,000
Total Profit: R60,000
Brokerage fees: R800 (possibly greater depending on your broker, and their roll-over fees – there would have been one roll-over)
Duration: 120 days
% Profit: 328% (in 120 days)

As I build this website I am gradually adding to the glossary, which explains some of the more technical terms. If there’s something that confuses you, that hasn’t made it into the glossary, or if you are interested in this sort of analysis, and would like to discuss it, or would like me to consider a particular share of interest to you, please let me know by adding a comment to this post, or by email: david@sentientcode.com.

I’ve been trading for over 15 years, and I’ve traded many things, including shares in South Africa, shares in the US market, futures on the S&P500 and Nasdaq, currencies, single stock futures, and so on. Trading fascinates me.

The Potential of Trading
Trading offers the potential, if one knows what one is doing of providing a perpetual source of income. I say “if one knows what one is doing”, because I have learnt the lesson of “not knowing” the hard way (one day I’ll tell the story of how I lost $5,000 in a single day). And after spending a good deal of the last 15 years studying everything I could find about how to trade “knowingly”, I do believe that I’ve found a way of doing it. This “way of doing it” is what I call “The Trading Theory”.

The Trading Theory
This is a trading theory inspired by the original work of JM Hurst, who studied cycles in the stock market (in the late 1960’s and 1970’s). I have added to the theory some extra details, and I believe the theory works (in other words one can make money by trading it) … I have spent a lot of time studying it, looking at it from every angle, and I still believe it works! So what’s the catch? The catch is that this is not a simple theory. It’s not a get-rich-quick theory. It is complicated, and involves several “barriers to entry”:

• a lot of mathematics
• some pretty complicated data crunching (also mathematical, but involving some additional ideas like spectral analysis)
• a willingness to overlook the “why does this happen?” question, which many people find difficult.
• the necessity of applying a visual pattern-recognition ability.
• the applying of a specific logic which takes a while to grasp, and a pretty long time to master.

So in order to do all these things, and really put the theory to the test, I am creating the software which this blog is all about. To really do the trading theory justice one needs something to help one overcome the barriers I’ve described above, and I think software is just the right thing.

The Problem with Trading
I have many friends who “trade”, in which description I include those who buy stocks and shares for longer term invetsment. Trading is pretty easy to get into – open an account somewhere, pick a share/currency and then buy it! All too often I believe people get into trading (or longer term investing) without knowing what they are doing, and often do really well for a while (sometimes even years). But then just when they think they know it all, they start losing money, and before they do know it all they’ve lost everything they made in the first place, plus a bit more.

Why does this happen time and again? Because people who trade (or invest) in this way don’t actually know what they’re doing. I know that’s harsh, but most of the time it’s true. There is a well-known saying in the trading world: “don’t mistake a bull market for your own genius”. If you buy shares in a bull market (which is a rising market) they are pretty much bound to go up. If you then make the mistake of thinking that it was your genius that guided the choice of share, or the time at which you bought the share, then when the market turns into an angry bear (as is happening pretty much worldwide at the moment) and starts falling, you’re going to suddenly realise how little you actually do know.

My favourite question to friends and people I meet who also trade is: “what guides your buying and selling decisions?” Would you believe me if I said that most people don’t really have a “theory” they work with? They listen to other people’s opinions on the radio and TV, and vaguely make a decision based on their “gut feel” about a share. Sure, some of the time they’re right, but let’s face it: some of the time they’re not! That’s all very well if it’s a hobby that amuses you, but if it’s your plan for the future, I think that is pretty disastrous. The way many people talk about trading reminds me frighteningly of the way gamblers speak about their gambling exploits: A gambler will phone their friends in great excitement on the occasion of a big win (a big party for all the friends, everyone talking about how the gambler has a “lucky gene”). But what happens when they lose money? Do they phone all those friends? Not likely, unless they need a loan, and so one tends only to hear about all the wins, and none of the losses. All too often I find that happens with traders I have met – great stories about making thousands of dollars in a few days, but not so many stories about the losers. The problem is I think those people are doing little more than gambling with their money. For their sake I really hope their lucky streaks hold good as the world markets twist and turn.

Most of them answer any concerns I express with the stock response of – “in the long run stock markets go up, even if it means you have to wait a little longer”. I must say I think that idea has run its course – there is no rule anywhere saying that stock markets cannot start going down, and keep going down. And even if a market always has to turn back up again, what if it only happens in 80 years time? Might be a little late to enjoy the upturn! I’m a keen reader of Robert Prechter’s The Elliott Wave Theorist in which he often discusses spurious ideas such as the belief that stock markets must inevitably go up. If you’re interested in trading well, I highly recommend his newsletter – you might not agree with all his ideas, but it’s always good to question one’s own beliefs now and then.

The Challenge
And so for me the challenge is to trade in a way that can be genuinely defined as “knowing what you’re doing”. Obviously everyone has their own idea about what that means – and this project is my own personal quest to find the solution to that question. Perhaps I should say “to express the solution”, because I believe I have found it already, I just need to find a way of expressing it so that others can use it and benefit from it. I would love for all my friends, acquaintances, and many others to use my software to make themselves wealthy, because that is what it’s all about – sharing the knowledge of how to trade.

It would be so much better than hearing that friends have bought shares in a stock that I’m convinced is going down … but tact prevents me from saying anything. I think the time for tact has passed.

My background
I came to trading in an unusual way, which might inform my readers a little! I knew the stock market existed, but it never held any interest for me because it all sounded like serious business, and my only awareness of it was when the closing prices of many shares were announced on the radio in South Africa. It all sounded so boring. I admired the way the radio DJ’s would vary their tone of voice as they announced each share price so that it didn’t sound too monotonous, but inevitably my mother would change the station to something musical, and that would be it.

But then I developed a strong interest in gambling games – roulette, blackjack and the horses. I know one’s not meant to mention gambling and stock market trading in the same breath but I’ve done it twice (or three times) now in one blog, and the reason is that I believe the two do have many connections. What fascinated me about the gambling games was the mathematical side of things – the concept of probability and the statistics of chance. A wonderful book called Thirteen Against the Bank by Norman Leigh inspired me to team up with a friend and “beat the bank” but that’s another story for another time (the system doesn’t actually work mathematically – I guess Norman and his team were lucky). When researching a theory I had about the potential of making money out of statistically based bets placed on the Horse Racing pools (again another story altogether…), I came across the concept of time series, and ended up reading a book about the technical analysis of stock market prices. I was immediately hooked, and have spent the last 15 years reading pretty much everything I can on the subject. My particular interests are technical analysis (perhaps that’s obvious!), but more particularly the fields of Elliott Wave analysis, and Cyclic Analysis (with emphasis on the work of JM Hurst, and those who have followed him).

When I was 12 years old my father returned from a business trip to the UK with a small box called a “ZX80 computer”. In those days it was a complete novelty – kind of like a toy, but somehow much more than that. I taught myself to write simple computer programs using the BASIC language the ZX80 used, and even dabbled in some assembly-code. I never did any formal training in software programming, but it has been a hobby that recently has developed into something much more serious.

The thing is I believe that computers are the thinking machines that Alan Turing dreamed of back in the early 20th century. I further believe that we haven’t even begun to see what computers can do, that with the right software programming computers can replicate the thought patterns of humans, albeit in a limited way. And that is why this project of mine involves the creation of software.

The Dream!
One day many thousands of people will use this software to make their trading decisions for them. Why? Because these people will be too busy doing other things to spend all their time watching the markets, studying trading theories, or mastering the skill of trading. The software will do it all for them … Trading is best done without emotion – and until computers start to feel emotions, who better to do your trading for you than your computer?

I keep writing all sorts of nonsense on this blog, but the one thing I haven’t got to yet is what the software is doing right now. That’s because I’ve thought I needed to prepare the ground, explain things, describe the trading theory at length … but instead I’m just going to take the plunge. Pictures say it all:

This is a chart of the Euro-USD exchange rate, produced by the software, analysing data up to Friday 30th May 2008.

• The thick BLUE line is the “price” line – the exchange rate between the two currencies.
• To the right you will see the price scale, with the closing price of Friday 30th May highlighted in a red box – it is red because the price has FALLEN (is lower) from the previous day’s closing price.
• The thin multi-coloured lines are the lines Hurst calls FLD’s – Future Lines of Demarcation.
• Price is surrounded by a “dominant channel”  the purple dotted lines that form an envelope around the price movement.
• Along the bottom of the chart is the last part of the phasing analysis for this chart. To the right you will see the cluster of small circles within lines, with a grey shaded background. This indicates that we expect a nest-of-lows within the next 7-10 days, with a strength of about 20 weeks.
• You will also see some VTL’s – Valid Trend Lines, as defined by Hurst. These are the straight dotted lines, with small boxed labels giving the wave period of the VTL.
• Notice also the TRIO of moving averages, moving around the price line. One is dark red, one blue and one green. These lines are not Hurst-inspired, but are a personal refinement by which I calculate refined FLD projections.

I’m not going to explain at length what this chart means because that would take several pages of discussion. For now I just wanted to give a glimpse of what the software is doing. Having said that, here is the commentary generated by the software, which pretty much does that for me:

Updated Phasing Analysis reveals that the dominant cycle has a wavelength of 16.9w, or 118 days. This is assumed to be the 20w nominal wave, which implies that all waves will be (-14%) shorter than nominal. This cycle is approaching a TROUGH (and a medium degree nest-of-lows). The underlying trend to this cycle is currently FLAT, likely turning DOWN. The future FLD indicates that this cycle will influence prices to peak in a short while, and then to fall.

The sub-dominant cycle (next wave down from the dominant cycle) has a wavelength of 58.9d, or 59 days. This is assumed to be the 80d nominal wave. This cycle is overdue for a PEAK. This is probably the second of 2 sub-waves. The underlying trend to this cycle is currently FLAT, likely turning UP. The future FLD indicates that this cycle will influence prices to peak soon, and then fall.

The pre-dominant cycle (next wave up from the dominant cycle) has a wavelength of 33.9w, or 237 days. This is assumed to be the 40w nominal wave. This cycle is approaching a PEAK. The underlying trend to this cycle is currently strongly UP. The future FLD indicates that this cycle will influence prices very little because despite near-term volatility the FLD becomes range-bound.

Σ L is currently FLAT. (value of: 0.0)

The last phasing analysis was 4 days ago. In that time price has FALLEN by 244 to 15521.
Sequence #1 of the previous pattern: Price did move DOWN (for 3 days) as expected and has moved towards the target of 14954. The closest price has gotten to this target so far is 15394 (2.9% short) 1 day ago. This target is now 38 days away.
This brings the price movement up to date. From this point on:
Sequence #1 is expected to reach a LOWER target of 14808(-146 diff) 4 days EARLIER, on 2008/06/12 Recent price action has generated a new sequence (# 1). The target of this projection is 13624, expected by 2008/10/06.

CURRENT PROJECTION PATTERN:
Price is currently range-bound (last close 15521), in an active FLD pattern cascading down. Price crossed below the 15 day FLD 1 bar ago, implying a price fall to 15467. This move would imply a price cross below the 29 day FLD (est: 2008/06/03 & level: 15498) projecting price to a CONGESTION PAUSE ZONE at approximately level 15436  Then price is likely to CONTINUE DOWN after a pause, towards fulfilling the 16 week cycle projection of 15402  taking price into a CONGESTION PAUSE ZONE at 15431 by about 2008/06/09  Then price is likely to CONTINUE DOWN after a pause, towards fulfilling the 59 day cycle projection of 15342  taking price into a CONGESTION PAUSE ZONE at 15429 by about 2008/06/09 . This price move breaks below the 33 week VTL implying that the peak on 2008/04/23 is the expected peak of the 15 month cycle. Then price is likely to CONTINUE DOWN after a pause, towards 14866 by 2008/08/09, attempting to fulfill the projection generated by the crossing of the 58 day FLD taking price into a CONGESTION PAUSE ZONE at 15257 by about 2008/07/03 . This price move breaks below the 16 week VTL implying that the peak on 2008/04/23 is the expected peak of the 33 week cycle. Then price is likely to CONTINUE DOWN after a pause, towards 14522 by 2008/11/09, attempting to fulfill the projection generated by the crossing of the 33 week FLD taking price into a CONGESTION PAUSE ZONE at 14782 by about 2008/10/05 . This price move breaks below the 15 month VTL implying that the peak on 2008/04/23 is the expected peak of the 46 month cycle. Then price is likely to CONTINUE DOWN after a pause, towards 13572 by 2009/07/15, attempting to fulfill the projection generated by the crossing of the 15 month FLD taking price into a FINAL REVERSAL ZONE

There is no cycle which provides an average potential of at least 20% per half-cycle, and so it is not recommended that you trade this stock unless you are trading on a leveraged basis, in which case you should change the Trading Settings by using the Tools|Trade Settings|Edit menu.

Having reviewed the entire projection sequence I am unable to find a move suitable for trading, and so no trades have been set up.

 Well – that’s what the software is “thinking” about the Euro-USD as of the 30th May. It seems pretty likely that things are going down, and that the upcoming nest-of-lows will generate little more than a temporary upward correction to the downward move. However it is early days for the software, and so I am by no means making any kind of call on this, I merely put it up here to show what the software’s doing at the moment.

I’m not a blogger – let me just put that out there right up front. I have always rather scorned the concept of making a diary “public”, but I have had an epiphany of sorts and have realized (I guess about 5 years after everyone else) what the value of a blog is, and what I hope to achieve from this blog – I want to share my ideas, and find someone or perhaps some many to talk to about them. As my wife’s eyes glaze over whenever I mention my software project, I reckon it’s about time for me to find some other(s) to talk to about it.

The Project
In August of 2005 (almost 3 years ago as I write this) I started working on a personal project which has become the subject of this blog – I decided to create software for use in trading (of stocks/ shares/ forex, you name it) which would be able to replicate all (or most) of the thought processes that go into an approach to trading that intrigued me (I’ll discuss this trading approach in detail in a later blog). I know that’s a tall order, or at least I have realized over the past 3 years what a tall order it is, but I believe I am beginning to realize the dream, and I feel the need to share the project with others who might be interested.

Because here’s the thing: I have tried a good many of the trading software packages out there, and I have been disappointed with most of them. The “black box” software has never appealed to me (so to be fair I’ve never given it a good run) because I’m the kind of person who likes to make my own decisions, particularly when my own money is on the line. And other analytical packages I have found frustrating because either:

• They are purely “charting packages” some of which allow you to design your own indicators. These are great for what they are: they are like the word-processors of the trading world – they deliver fantastic looking charts, but their greatness rests in the hands of the user! I want to create something that is beyond a tool.
• Or, they are software packages that go one step further and analyse the data according to some or other theory, but then take no “responsibility” for that analysis, by which I mean that there is no continuity from one day to the next. One day the software will be predicting a bull move, and the next day (after the market crashes heavily) the software happily tells you that it was predicting a bear market all along. How often have I agonized over a trade, finally taken the plunge, pulled the trigger, bought the stock, only to lose money and the accursed software has no memory of the false prediction it gave.

I’m a little obsessive. I have tested many software packages by stepping them day by day through the data – and I have yet to find one that really works consistently across all market conditions and several markets. And yet in my (fairly extensive) reading on the subject I have come across at least one theory about the movement of stock market/currency prices that really seems to make sense, and which should work. And hence the project that is the subject of this blog – to create software which will be able to:

• Analyse the stock market according to “the theory” – I will be writing much about the trading theory the software uses later.
• Make “intelligent” trading decisions, in terms of:
  • Trade entry (buy and sell signals)
  • Trade monitoring (including the facility to “know” why the trade was initiated in the first place)
  • Trade exit – selling (or covering short) at the appropriate time and price.
• Furthermore, the software should have some concept of continuity over time (in other words if an analysis changes it should recognise that fact!)