VantagePoint : Charles H. Dow Award Submission Book Synopsis for Louis B. Mendelsohn’s Book: Trend Forecasting with Technical Analysis
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The Charles H. Dow Award, sponsored by the Market Technicians Association, Bridge Information Systems, Barron’s, and Dow Jones Newswires, is awarded to the work that breaks new ground or makes innovative use of established techniques in the spirit of pioneering market technician, Charles H. Dow.
The following synopsis of Mr. Mendelsohn’s book “Trend Forecasting with Technical Analysis: Unleashing the Power of Intermarket Analysis to Beat the Market” summarizes the intent, methodology and conclusions of his book, in accordance with the Submission Guidelines. This year’s winner will be announced at the Market Technicians Association’s annual meeting in Chicago, May 17 – May 20, 2001.
Charles H. Dow Award Submission – Book Synopsis
Trend Forecasting with Technical Analysis: Unleashing the Power of Intermarket Analysis to Beat the Market
By Louis B. Mendelsohn with Foreword by John J. Murphy
This book explores the application of intermarket analysis, which analyzes the relationships between individual financial markets and their effects on one another, to trend forecasting. It discusses the advantages of using intermarket analysis in combination with traditional single-market technical analysis to identify the current market trend and forecast its direction in today’s highly interconnected financial markets.
The book argues that intermarket analysis is a logical extension of technical analysis and is not a substitute or replacement for traditional single-market technical analysis approaches and methodologies. Rather, the author suggests that intermarket analysis should be used in conjunction with single-market technical analysis concepts, methods and indicators. This combined approach retains and builds upon the strengths of single-market analysis, while broadening the framework of analysis to quantitatively take into consideration the interdependencies of today’s financial markets. By combining these two methods of analysis traders gain greater insight into market behavior from an intermarket perspective, thereby allowing them to forecast the short term trend direction of a given target market with greater accuracy, which is, after all, the underlying purpose of technical analysis.
The technical focus of the book’s presentation is on how intermarket analysis, implemented by applying a mathematical tool known as neural networks to quantify intermarket relationships, can be used to forecast moving averages. By incorporating these forecasted moving averages into more complex indicators, such as moving average crossover strategies, the “lag” effect inherent in the mathematical construction of calculated moving averages can be overcome. This transforms moving averages from a lagging to a leading technical indicator, greatly increasing their effectiveness as a trend identification and forecasting tool. The author believes that the application of this widely-used technical analysis indicator within the framework of intermarket analysis through the use of neural networks, as presented in this book, breaks new ground in technical analysis and makes innovative use of an established market analysis technique.
Chapter 1 addresses the globalization of the financial markets and outlines some of the major factors that the author believes are responsible for the emergence of the “global economy”. It discusses the influence of telecommunications and information technologies on the evolution of the financial markets, and the likelihood of increased intra-day and inter-day market volatility in the 21st century. It questions whether a globally interdependent communications and trading network, toward which the financial markets are heading, will mitigate or exacerbate global financial crises in the future. Further, it suggests that robust intermarket analysis tools and information will become increasingly more critical in determining the success of both short term traders and long term investors in the global financial futures and equity markets.
Chapter 2 highlights the strengths and weaknesses of traditional technical analysis methods, particularly single-market analysis which looks internally within each market, and the nearly exclusive reliance upon “lagging” (and often subjective) trend-following indicators. It discusses the underlying goal of technical analysis which is to identify and forecast the market trend direction of financial markets, in order to assist traders in making more profitable trading decisions. The author argues that traditional single-market technical analysis has not kept pace with structural changes that have globalized the financial markets and that traders who continue to focus their analysis solely on each individual market fail to see the “full analytical picture”.
Chapter 3 introduces intermarket analysis as a logical extension of traditional technical analysis and offers various ways that traders can use intermarket analysis to expand their analytic perspective in order to take into consideration external (as well as internal) factors affecting each market. The chapter outlines several rudimentary intermarket analysis methods currently employed by traders and technical analysts. It examines the limitations of these methods, particularly in terms of constraints in the number of markets that can be simultaneously examined, the quantification of market inter-relationships, and the lead and lag effects between markets which these methods fail to address. The chapter discusses how intermarket analysis can be combined with traditional single-market analysis to create a more robust depiction of the myriad of factors affecting a target market. The author suggests that intermarket analysis should be used as a confirmation filter with various single-market technical indicators to help traders avoid marginal trades indiscernible using only a single-market approach. The chapter concludes that intermarket analysis is neither a radical departure from traditional technical analysis nor an attempt to undermine or supplant it. Instead, the author argues that intermarket analysis is simply the next stage in the evolution of the overall field of technical analysis, necessitated by the global nature of today’s interdependent, highly complex economies and increasingly integrated financial markets.
Chapter 4 discusses the strengths and weaknesses of traditional moving average lagging indicators, and demonstrates how neural networks can be applied to intermarket data to forecast moving averages. Then this chapter explores how forecasted moving averages can be utilized as components within moving average crossover strategies which compare predicted moving averages with calculated moving averages in order to forecast trend direction. This creates “forward-looking” trading plans that do not lag behind the market, but instead are able to indicate when a market is about to change trend direction. This methodology eliminates the lag effect associated with moving average analysis and transforms this popular technical indicator from a lagging into a leading technical indicator.
Chapter 5 describes VantagePoint, a neural network-based intermarket analysis software program first developed by the author in 1991. VantagePoint forecasts moving averages which when used as components within crossover strategies allow traders to call market “tops” and “bottoms” and predict market trend direction. This chapter also presents various market timing trading strategies for use by both day traders and position traders in making entry and exit decisions and determining stop placement.
Chapter 6 looks at the application of neural networks to intermarket analysis and briefly outlines the basics of neural networks and how they can be applied in today’s global markets. It also discusses the similarities and differences of “training” neural networks with the back-testing and parameter optimization of rule-based single-market technical indicators, and discusses some of the pitfalls to avoid when developing neural network applications.
Chapter 7 presents the author’s ideas about the evolution of the field of technical analysis in the early years of the 21st century. It suggests a comprehensive analytic approach which the author refers to as “Synergistic Market Analysis”, which amalgamates traditional single-market technical analysis with intermarket analysis and fundamental analysis into one unified framework for the purpose of market analysis and trend forecasting. This concept of combining these three means of analysis expands upon an earlier discussion by the author about the impact of technology on the role of the technical analyst and the scope of technical analysis entitled “It’s Time to Rethink the Role of Technical Analyst” which was published by the author in the September, 1991 issue of the Market Technicians Association Newsletter (the author has been a full MTA member since 1988).
In summary, this book discusses the integration of the world’s financial markets and the application of intermarket analysis in developing and implementing effective trend forecasting and market timing trading strategies. These strategies can be used in conjunction with traditional single-market trend-following indicators in the equity, options, derivative and futures markets to expand the scope of technical analysis from a strictly inward-looking, single-market perspective to a more inclusive intermarket perspective that encompasses the interdependencies and influences between related financial markets.