Chapter
Rotation
Originally presented in May 2001, this is a longer-term position trading system
designed to trade (from the long side) the two strongest indexes of the Dow Jones
Industrial Average (DJIA), NASDAQ 100, and the S&P 500. As a partial hedge,
the system goes short in the weakest market. The logic behind this system rests on
three assumptions:
The stock market has a long-term upward bias. Always having a long posi-
tion in two out of three markets should capture this bias.
When a market proves itself to be stronger or weaker than other markets, this
relationship is likely to continue for some time.
If a large, adverse move occurs, it will likely affect all markets simultane-
ously, but will be particularly devastating for the weakest market; therefore, this
market will be reserved for short trades only.
The indicator used to calculate the relative strength of the three markets is
similar to the 80-day moving average slope (MAS) indicator described in
“Building a Better Trend Indicator” (Active Trader, May 2001, p. 80). However,
instead of analyzing each market directly, the MAS indicator is applied to the ratio
between two markets (i.e., market one divided by market two).
When one market is gaining or losing strength relative to another market, the
80-day MAS indicator’s 20-day slope (today’s MAS—the MAS 20 days ago) will
change direction. Trades are signaled when the short-term volatility is less than the
long-term volatility, as described in the rules.
Suggested Markets
Index tracking stocks (SPDRs, DIAs, QQQs), futures, and currencies.
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