Most people that utilize relative strength are familiar with the calculation versus a benchmark index and then ranking those calculations over a specific time frame such as six months. This is the calculation that the Prudent Trader has used since inception, on stocks, ETF's, Sectors and Industry Groups.

However we’ve recently begun to calculate an internal relative strength.  Instead of measuring the instrument against an index we measure it against its own long term moving average.  In essence you’re measuring the distance the instrument is from that long term moving average either above or below.  We then rank those figures against all other stocks or sectors or groups to see where they stand relative to others. 

You might expect the ranking process to turn up identical rankings, I know I suspected that.  However there are subtle differences, not necessarily major differences, but differences nonetheless.  Below is a picture of the rankings by both methods for the 30 Morningstar Sectors.  The last column is the difference in the rankings.

As you can see the number one and two spots flip flop depending upon the methodology – not a big deal.  However, Wholesale for example, ranks the eleventh strongest against the NYSE index but seventeenth strongest against its long term moving average.  On the other side of the coin Materials and Construction ranks better utilizing the internal method over the benchmark method.

Does it matter when it comes to your analysis? That’s hard to say at this point, experimentation and observation continues on the subject.

This mornings economic data releases: Import prices -6.7% vs. a consensus of: -4.7%, International trade balance  -$67.2 billion vs. a consensus: -$53.5 billion, and the Weekly Jobless Claims 573K vs. a consensus of: 525K.

Overseas markets are mixed to a bit higher this morning: Nikkei 225 +0.70%, Hang Seng +0.23%, Shanghai Composite -2.28%, DAX -0.82%, and the FTSE 100 +0.36%.

Shortly after the above economic reports the futures are: Dow -120 , S&P -13, Naz -18, Oil +$1.70, and Gold +$19.50.

Last Friday I presented a back test for a potential market timing methodology.  That back test was based on Victor Sperandeo’s SPDTI formula.  Today I’ll be looking at another potential market timing tool; a modified Donchian Channel with a qualifying filter.  For those unfamiliar with the channel; The Donchian Channel is a very simple trend-following indicator developed by Richard Donchian. It plots the highest high and lowest low over the last n-periods time intervals.  Historically the n has been 20 days and it also became known as the four week rule.

The chart below shows the signals generated by our modified version with a qualifying filter for two time periods this market is often compared to; the 1930’s and the 1970’s.  As with last weeks back test operation I’m looking to see how it performed in these time frames. The green arrows show entry and the red arrows exits.  You could of course use the red arrows as short signals if you so desired.

You can see in the above chart, during these frustrating time frames, this methodology performed rather well.  Yes it was whipped around a little bit but for minor gains and minor losses. The key, in this author’s humble opinion, is it kept you out of the market (or short) during the large declines. The kind of situation I think we’re all looking for; cut your losses short and let your profits run. In 2008 this methodology produced two long trades; April 1 through May 9 a gain of 4.84% and May 19 through May 21 for a minor loss of 1.24%.  Not bad at all!  The methodology presented last week had no trades on the long side in 2008. 

The same methodology is also back tested, and included in this spreadsheet , against the S&P 500 and Nasdaq Composite; if the methodology has merit the readings should be very similar only with less data and a shorter time frame of testing.  The trade data for this back test is located under last week’s test data. We are moving closer to the Market Timing/Stock Selection section’s (See Tab Above) completion.

Louis Lukac, former Director of futures research for Prudential Securities, launched in 1990, Wizard Trading along with Jack Schwager. Louis Lukac, is a big fan of Donchian's channel rule; it always seems to test well against other well-known techniques.

Later today or perhaps tomorrow look for links in the Timing & Selection Tab above to Market timing charts, explanations, as well as our new Watch List along with potential entry and exit points. The entry and exit points allow one to calculate the risk involved and determine the position size you should take.

Charter members receive not only all that is currently in the member area but all future additions as well.  A Charter member will be defined as one who is a donating member by the end of 2008.  Beginning in January future members will get to choose between different plans, i.e. everything or just market timing and stock selection as an example.