Setting and Confirming Buy and Sell Signals for Cyclical Price Patterns

I (Richard Howard) buy and sell semiconductor equipment stocks like Kulicke & Soffa (KLIC), Amkor Technology (AMKR), Asyst Technologies (ASYT) and Credence Systems (CMOS). These stocks regularly complete prices cycles with predictable upsides and downsides. And if I buy early in the upside, profits can come in a hurry.

One simple method I use to decide when to a buy or sell a cyclical stock is to compare its daily closes with their 20-day simple moving average (SMA). When the closes fall below the SMA, I conclude prices are probably on the downside and it may be time to sell. When prices are above their 20-day SMA, I assume that an upside is forming.

But one shortcoming of this simple rule is that daily prices often fluctuate above and below the SMA, particularly at tops and bottoms of cyclical patterns. So I don't get consistent buy or sells signals from day to day at crucial times when prices are changing direction. I can eliminate part of this problem by using a 50-day moving average, but then the lag between the actual peak or bottom and the sell or buy signal becomes longer.

To solve this dilemma I apply two additional measures to confirm that a prolonged upside or downside move has formed. They are the cumulative percent winners (CPW) and cumulative returns (CR). These measures trend up and peak during a price upside and trend down and bottom during a price downside. The peak CPW lags the price peak or price bottom and the CR peak lags the CPW. So when the CPW and CR daily values fall below or above their 20-day simple moving averages, I am very sure that the change in the price direction is for real and will be prolonged. Then I have confidence to buy or sell the stock.

The complete price cycle for Kulicke & Soffa from September 12, 1996 through October 8, 1998 illustrates the use of this three-measure technique. The example shows how the price SMA, CPW and CR are used to determine if prices have moved from the upside to the downside.

The daily close made a double top on September 23, 1997. The first sell signal was on September 25 when the daily closes fell below their 20-day simple moving average.

The daily cumulative percent winners peaked on September 27, 1997 and then fell below their 20-day simple moving average on October 7, 1997. At this date prices were still below their 20-day simple moving average and headed down. So the first sell signal was confirmed.

The daily cumulative returns peaked on October 3, 1997 and fell below their 20-day simple moving average on October 16, 1997. Prices were still below their SMA indicating that prices are on the downside. So the original sell signal was confirmed again.

You may also use the The Price Direction Indicator (PDI) to confirm a buy or sell signal. The daily PDI is simply the sum of the daily cumulative percent winners and cumulative returns. The PDI usually peaks after the cumulative percent winners peak. And it peaks on the same date or shortly after the cumulative returns peak.

For the KLIC example, the daily PDI peaked on October 3, 1997 and it fell below its 20-day simple moving average on October 14, 1997.

Related Articles:

Confirming a Change in Price Direction with the Price Direction Indicator (PDI)
Price Direction Indicator (PDI) Detects Changes in Price Direction

Posted March 20, 2006. Updated September 10, 2007.