Book Reviews, Trading

Book Review of Mastering Market Timing by Richard Dickson and Tracy Knudsen

The full title of this book is Mastering Market Timing: Using the Works of L. M. Lowry and R. D. Wyckoff to Identify Key Market Turning Points by Richard A. Dickson and Tracy L. Knudsen, CMT. Both Richard and Tracy work at Lowry Research, which I presume carries on the works of Lyman M. Lowry.

This book brings together material from Wyckoff’s Stock Market Correspondence Course, and Lowry’s Buying Power and Selling Pressure tools, among others, to analyze major market tops and bottoms. The key takeaway is basically on the analysis of demand and supply at the tops and bottoms, and using other tools (e.g. 90% Days, A-D Line, % of stocks above 30-week moving average) to confirm the analysis.

I learnt three things from reading this book:

  1. On establishing a price target of a move after a consolidation phase. The P&F chart method to establish a price target is a crude way to do it due to the availability of information and processing capabilities during that time period. With today’s technology, one can much more accurately estimate the amount of accumulation / distribution during the consolidation, and then track the amount of distribution during the mark-up phase to know when a stock is topping out.
  2. The topping out of individual sectors can take some time during the market top. For example, during the 2000-2002, the last sector topped out 3 years after the first sector that topped. In the 2007-2009 crash, the last sector topped out more than 1 year after the first sector that topped. Hence it is actually possible to play some kind of sector rotation during the market topping process. Livermore did that, as highlighted in his book. It is dangerous to start being a bear across all sectors if that particular sector has not yet topped. Hence there needs to be more detailed sector analysis before switching to a “market” bear.
  3. Looking at the charts of various market tops helped me to figure out whether using the trend of the 50-day moving average is a good way to identify market tops. One method that I have come across basically confirms a topping only after the 50-day moving average of the index has turned down. From looking at the charts of all the tops, this works pretty well except for I think in 2000 where the market sliced through the 50-day so quickly that by the time the 50-day moving average turned, the market was already down by a lot. Hence the 50-day moving average can serve as a lagging indicator to confirm the topping, but the actual topping process should still be analyzed using supply and demand analysis of the action.

The book did not provide formulas for Lowry’s Buying Power and Selling Pressure indicators, which are apparently proprietary. I did not find any free source that actually plots these indicators so their use might be limited. I had also read in one of William O’Neil’s books that buying power and selling pressure does not work. I have not done my own analysis on them to test them out, but regardless I am never comfortable using something that I don’t know the details of.

Overall, I like this book for the Wyckoff portion of identifying market tops and bottoms. I would love to go through the original Wyckoff material when I find the time.

Lowry’s Buying Power and Selling Pressure

  • Total buying desire and total selling desire determines the direction of the trend. These two desires are measured using four calculations
    • Total point gains for stocks closing higher on the day
    • Total volume for all stocks closing higher on the day
    • Total point losses for all stocks closing lower on the day
    • Total volume for all stocks closing lower on the day
  • Buying Power is a 50-period (50 trading days) index that evaluates upside action both in terms of actual points gained and related upside volume.
  • Selling Pressure is constructed from the actions of declining stocks in terms of points lost and downside volume.

Lowry’s 90% Days

  • Introduced by Paul Desmond of Lowry Research in 1982.
  • 90% Up Day occurs when Up Volume is 90% or more of the trading session’s total Up plus Down Volume and Points Gained is 90% or more of the total Points Gained plus Points Lost for the session.
  • 90% Down Day occurs when Down Volume is 90% or more of the session’s total Up/Down Volume and Points Lost is 90% or more of the total Points Gained/Points Lost.
  • 90% Down Days most frequently occur at the time of PSY (see below).

Identifying a Major Market Topping Pattern

  • Two phases
    • Distribution of stock from strong to weak hands.
    • Dominance of supply over demand, leading to the collapse of the bull market into a new bear trend.
  • Phase #1 – Distribution to weak hands
    • Preliminary Supply (PSY)
      • Prices move higher in smaller amounts with same volume, followed by a heavy volume pullback (first evidence of aggressive distribution).
    • Prices recover
      • Buyers come in late to the rally thinking it is an opportunity.
    • Buying Climax (BC)
      • 1 or 2-day spike with extremely heavy volume.
      • Buyers dump into the BC resulting in a close near the low for the day (for a 2-day BC, the low is recorded on the second day).
      • BC is the final exhaustion of strong demand. Most of the stock is now held by weak hands.
    • Automatic Reaction (AR)
      • Sellers step up, price declines on relatively heavy volume.
      • The lower limit reached by the price on this decline usually defines the lower limit of the trading range of the topping formation.
      • Marks the start of active distribution.
    • Secondary Test (ST)
      • Buyers see the pullback as a temporary pause and price rallies again.
      • If demand remains strong, the Secondary Test rally surpasses the top of the BC with heavy volume.
      • If demand is weak, it is accompanied by weak or falling volume, and a shrinking of the daily range (between the intraday high and low).
      • The highest price reached in the ST typically defines the upper limit of the topping formation.
    • Distribution continues in a series of secondary test rallies and reactions.
  • Phase #2 – Supply overcoming demand
    • Upthrust (UT)
      • Prices move to a new high or test the highs formed during the Secondary Tests, on moderate to heavy volume.
      • An UT is short-lived and prices quickly fall back on moderate to heavy volume because much of the stock bought on the UT is in weak hands who face immediate losses on any market pullback.
      • UT is a sign of weakness because it does not lead to a sustained breakout from the trading range. Last grasp for strong demand.
    • Sign of Weakness (SOW) reaction
      • Sharp decline in price and significant rise in volume.
    • Last Point of Supply (LPSY)
      • Rebound rally resulting in a move to the LPSY.
      • Retraces half or less of the SOW sell-off and occur on light or diminishing volume.
    • Falling through the Ice
      • Final breakdown from the trading range through the low points reached on the AR and the SOW, on heavy or increasing volume.
  • Note that if the above did not play out, the uptrend may have more room to run.

Identifying a Major Market Bottom Pattern

  • You need to see extremely heavy or light volume (i.e. either of the extremes) to get a rally of any consequence. Extremely light volume starves the decline, while extremely heavy volume kills the decline.
  • Phase #1 – Panic and capitulation
    • Preliminary Support (PS)
      • After a sudden surge in volume or a lack of it to further fuel the decline, a notable rally occurs.
      • This rally stands out among other upside reactions in terms of price gain and volume as it breaks above an area of overhead Supply.
      • More often that not, PS will occur in the form of a 90% Upside Day.
    • Selling Climax (SC)
      • Investors realize the PS rally is not the start of a major move higher.
      • They dump their shares and exhaust the Supply, which actually stops the decline.
      • Often shows up as more than one 90% Down Days in close proximity.
    • Automatic Rally (AR)
      • Wave of buying supplemented by short covering.
      • Often occurs in the form of one or more 90% Upside Days, typically lasting roughly a week.
      • High of the AR represents the upper limit of the trading range of the market bottom.
    • Secondary Test (ST)
      • Those that bought at or near the SC know that there is no firm reason as yet to expect an important up move, so they tend to be content with a relatively small, quick gain, which stifles the AR.
      • ST confirms the end of the decline by occurring on a much smaller amount of volume than at the SC, and the price should meet support at a somewhat higher level than at the SC. This point is not as essential as is the lower volume.
      • The lowest point of the SC or ST defines the lower edge of the bottom formation.
    • Springs and Shakeouts
      • Subsequent STs often take the form of Springs and Shakeouts, which show the inability of the market to sustain a break of support.
      • Springs prove the market’s inability to decline by penetrating a well-defined trading range support level on low or moderate volume, usually followed by an aggressive rally.
      • Shakeout is a sharp drop in price on heavy volume, which may bring a significant penetration of a prior support, followed by a speedy recovery.
  • Phase #2 – Accumulation and breakout
    • Sign of Strength (SOS)
      • Market makes a significant rally over a relatively short period of time and accompanied by a substantial increase in the level of volume.
      • Often results in a breakout from the sideways trading range that represents the major bottom formation.
      • Often comes in the form of one or more 90% Up Days.
    • Jump Across the Creek
      • The Creek is the upper edge of the trading range that represents the major bottom formation.
      • The breakout above the Creek must be accompanied by a surge in volume.
    • Last Point of Support (LPS)
      • Buying on an advance carries higher risk. Resist the urge to buy on the aggressive showing of a SOS rally, wait for the next reaction, which is the LPS.
      • Relative strength is implied if a reaction meets support at or above the halfway point of the previous rally. If the volume is greatly reduced from that of the previous rally and if support is being met at or above the half way point of the rally, it is reasonable to conclude that a LPS (also qualified as a Back Up to the Edge of the Creek) is being experienced. Therefore, it is justifiable to take a long position.
  • Note that if the above did not play out, the downtrend may have more room to run.

How Wyckoff Uses Point and Figure Charts to Establish Price Targets

  • Constructing a P&F chart
    • Size of each box given a fixed points per box.
    • Wyckoff uses a one-box reversal, however a three-box reversal method (i.e. each column must contain at least three boxes) is now the most popular. Hence a price change of three full boxes is needed to start the next column.
    • X for rising prices, O for declining prices.
    • To put an X, the price must be at or higher than the y-axis price (rising column)
    • To put an O, the price must be at or lower than the y-axis price (declining column).
  • Estimating Price Targets
    • Method #1 – Horizontal counts
      • Look for the period in which prices move sideways in a relatively narrow range.
      • Estimated size of move = Width of this range (i.e. number of boxes) * Box size * Reversal Amount (i.e. 3-box reversal). E.g. if a basing pattern is 8 boxes-wide, with 2 points per box, and a 3-box reversal method is used, then estimated size of move = 8*2*3 = 48 points.
      • Target price = Estimated size of move + value of the lowest box in the range
      • [My note: This estimates the amount of points accumulated, i.e. each column represents accumulation of 3 boxes worth of points, hence each column represents 3*2 = 6 points of accumulation in the example above. Then multiply by the number of columns, which is the number of times the accumulation has occurred, either when the stock moved up or the stock moved down.]
    • Method #2 – Vertical counts
      • Count the number of boxes in a column of Xs or Os, multiplied by the reversal amount (3 for a 3-box reversal) to determine the projected target.
    • Wyckoff used only a horizontal count.
  • Application
    • Wyckoff used only a horizontal count to establish a target range.
    • Market bottoms
      • Width is taken from the PS to the LPS.
      • Low end of target range = Lowest point in the basing pattern + estimated size of move
      • High end of target range = LPS + estimated size of move
    • Market tops
      • Width is taken from the PSY to the LPSY (just below the ice).
      • Low end of target range = LPSY – estimated size of move
      • High end of target range = Highest point of the topping pattern – estimated size of move.
  • Using price targets is more hazardous to investment success than not. It is better to analyze supply and demand.

NYSE Advance-Decline Line and Major Market Tops and Bottoms

  • Market tops
    • Divergences between the Composite NYSE A-D Line and the major market indexes indicate the approaching end of a bull market.
    • This is due to selective, rather than wide-spread, selling at market tops.
    • However lead times can vary from an extreme of 23 months prior to the 2000 market top to just 1 month prior to the 1956 peak. Average lead time has been around 10 months, median of 7 months.
  • Market bottoms
    • There are no instances where the NYSE A-D Line provided any help in identifying a major market bottom.
    • To the contrary, in every major market bottom it recorded a new low right along with the price indices.
    • This is due to panic selling in a climax with wholesale dumping of stock, hence there is no selective buying to make the A-D Line diverge.
  • The NASDAQ A-D Line has a downward bias (peaked in 1957 and trended down since) because of the inclusion of many micro-cap stocks which fail to survive for long periods of time.
  • Major disadvantage is that the A-D Line provides no indication of the strength of an advance or decline.

Percentage of NYSE Issues Above Their 30-Week (150-day) Moving Average 

  • Look at the trend of the peaks and troughs of this indicator.
  • Market tops
    • Indicator shows lower highs while the market indices continue upwards
  • Market bottoms
    • Indicator shows higher lows while the market indices continue downwards.

Sector Tops Can be Decently Spread Out at Market Tops

  • 2000-2002 bear market
    • DJIA, S&P500, and NASDAQ topped between mid-January to end-March 2000, however the S&P 400 Mid Cap and S&P 600 Small Cap topped only in mid-April 2002.
    • Sequence of sectors peaking
      • Telecom: July 1999
      • Consumer Discretionary: December 1999
      • Basic Materials: January 2000
      • Info Tech: March 2000
      • Finance: January 2001
      • Utilities: April 2001
      • Energy: May 2001
      • Industrials: May 2001
      • Healthcare: March 2002
      • Consumer Staples: May 2002
    • Sectors with the 3 largest losses: Info Tech (82%), Telecomm (73%), Utilities (63%).
    • Sectors with the 3 smallest losses: Consumer staples (26%), Energy (35%), Finance (38%).
  • 2007-2009 bear market
    • All sectors were hurt, with losses in the major indices ranging from 50-60%.
    • All sectors topped between Feb 2007 (Finance) to May 2008 (Energy)
      • Finance: Feb 2007
      • Healthcare: May 2007
      • Consumer Discretionary: June 2007
      • Telecom: September 2007
      • Industrials: October 2007
      • Info Tech: October 2007
      • Utilities: December 2007
      • Consumer Staples: December 2007
      • Basic Materials: May 2008
      • Energy: May 2008
    • Sectors with the 3 largest losses: Finance (84%), Industrials (65%), Consumer Discretionary and Basic Materials (60%).
    • Sectors with the 3 smallest losses: Consumer staples (35%), Healthcare (40%), Telecomm (47%).

Recommended Readings

  • Paul Desmond’s “Identifying Bear Market Bottoms and New Bull Markets”
  • Victor de Villiers’ The Point and Figure Method of Anticipating Stock Price Movements (1933)
  • Alexander Wheelan’s Study Helps in Point and Figure Technique (1954)



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