Detecting the Downside Using CTM

The Complete Trading Model (CTM) demonstrates that you lose money when you buy on the downside. And common sense tells us to sell when prices move to a prolonged downside So before you buy or sell, you should decide if prices on the upside or the downside.

CTM has two indicators that will help you determine if prices have changed to the downside

Each CTM trade is a winner (makes money) or is a loser (does not make money). For each sell date of the price series CTM:

3. Divides the cumulative number of winning trades by the cumulative number of all trades.

For example, suppose trade 1 is a loser. After one trade the cumulative number of winners is zero, the running total number of trades is one; and the cumulative percent winners is 0%. Suppose trade 2 was a winner. After two trades the running total number of winners is one, the running total number of trades is two, and the cumulative percent winners is 50%. Continuing on suppose after 20 trades the running total number of winners is five, the running total number of trades is 20 so the cumulative percent winners 25%. Each sell date has a cumulative percent winners value.

Why Use Cumulative Percent Winners?

As you watch a price series unfold in real time, you see prices rise and then start to fall. You're not sure if the price increase signals a new downside or is just a temporary blip on the upside. Therefore, you need another measure to confirm if the fall in prices is for real and a new downside is forming. In short you need a second opinion. The cumulative percent winners serves as that second opinion.

The rational for the indicator is when prices move up, the cumulative percent winners moves up because fewer and fewer trades are losers. Eventually prices peak and then turn down and more and more trades are losers. Therefore, the values of the cumulative percent winners peak and then begin to turn down thus confirming the down move in prices. The cumulative percent winners peak sometime after prices peak.

3. Divides the cumulative sum of gains and loses by the cumulative number of all trades.

For example, suppose trade 1 lost 10%. After one trade the cumulative sum of return is -10%, the total number of trades is one so the cumulative return is -10%. Suppose trade 2 was a 15% gain. After two trades the running sum of the returns are 5%, the total number of trades is two, and the cumulative return is 2.5%. Continuing on suppose after 20 trades the running sum of the returns is -10% so the cumulative return is -0.5%.

Cumulative returns is used with the cumulative percent winners to confirm a change in direction of prices. As prices move up, the return for most trades turns positive so the cumulative percent return moves up. As prices begin to fall, returns turn negative and the cumulative return peaks and then turns negative.

The cumulative return indicator usually peaks after the cumulative percent winners indicator peaks. This lag is not troublesome because it builds in a wait-and-see time interval to establish the real downside move in prices. If you were to sell too soon, you could still be on the upside of prices.

To determine if prices have moved from the upside to the downside you examine simultaneously the cumulative percent winners, cumulative return and price. After all three turn negative and remain negative, you may infer that prices have moved to the downside. In real time you would monitor the CTM indicators and price to determine if the down trend continues.

How long the three indicators must stay negative for you to conclude the downside is in place is not a fixed time interval. An aggressive investor might say prices changed to the downside the instance the two indicators and price moved down together. A more cautious investor would monitor the trend for weeks. Another investor could use a longer monitoring period. The time you wait to "place your bet" depends on your investing style. Obviously the longer you wait, the higher the likelihood you rule out a false start to the downside.

After you think prices are moving to the downside, you can make a sell decision.

The following example illustrates how you look for a change in price from the upside to the downside. The next chart shows the historical prices for the upside of one price cycle and the downside of the next price cycle for Kulicke & Soffa.

CTM computes the cumulative percent winners for each week of the price series beginning at the bottom of the cycle. The cumulative percent winners and the cumulative return are based on the upside price series.

Note the left-hand side of the chart. At the beginning of the series the week-to-week values of the cumulative percent winners fluctuate widely because only a few data points are used in the computation. Therefore, one or two values can have a magnified effect on the total. This is simply a computational anomaly so ignore the first few weeks of the curve until the choppy pattern becomes smooth. After the wide fluctuations ended in the first few weeks, the cumulative percent winners dropped, were choppy, rose steadily and then started a prolonged down move.

The next chart shows the cumulative returns, which are based on the same KLIC upside price series. Like the cumulative percent winners, ignore the wide swings of cumulative returns at the beginning dates of the analysis.

The cumulative returns followed a steady rise until they peaked and then showed a strong continuous down move.

The upside to downside indicators table summarizes the movement of price, cumulative percent winners and cumulative returns. The column labeled CPW contains the cumulative percent winners data and the column labeled CR contains the cumulative return data. A red down arrow indicates a down move. A green up arrow indicates an up move. Remember, if you were watching the values in real time, you would not know when a price top occurred.

On September 29 price and cumulative percent winners turned negative but cumulative returns were still positive. On October 6 price, cumulative percent winners and cumulative returns turned negative. After October 6, the prices moved to the downside.

Conclusions and Recommendations

After cumulative percent winners, cumulative return and price turn negative and remain negative, you may infer that prices have moved to the downside. The length of time you wait to conclude prices are on the downside depends on your investing style. Obviously the longer you wait, the higher the likelihood you rule out a false start to the downside. But you may receive less when you sell if the downside is for real.