MARKET ACCORDING TO WILDER
by David Yu
August 22, 2005
We went over Mr. Dick Arms' market study by volume in my July 31 Sunday Chartmentary. This week, let's see what Mr. J. Welles Wilder, an engineer turned technical analyst, has to say about the current state of the market. While Dick Arms' volume study helps provide great insight into the market's supply and demand status, Welles Wilder's work helps identify market trends and momentum.
Let's first apply three of Welles Wilder's indicators to the S&P Index. Chart 1 shows 3 different movements of the market as identified by Wilder's RSI, Parabolic SAR, and ADX indicators. In mid March, all 3 indicators gave the "SELL" signal - see red circle.
The blue dotted curve of the Parabolic SAR (Stop And Reverse) hit the long position stop price target around March 14, when the S&P trended below this indicator. The Parabolic SAR is only effective when the stock's trending. Using other Wilder's indicators for trend confirmation is the best way to avoid the non-trending whipsaws. For that we go to both the RSI and the ADX.
RSI (Relative Strength Index) indicated the beginning of a downward momentum when it crossed below 50 on March 14. RSI is such a popular indicator that most chartists just take it for granted. Few have given much thoughts about how it's constructed. Wilder's RSI is based on the ratio of the average gains to the average losses over the recent period, which is 14 in our analysis. The 50 centerline is the neutral zone. When RSI crosses below 50, as it happened in March, it's considered bearish.
Meanwhile, the ADX (Average Directional Index), the thick black line, started moving upward while the red Negative Directional Indicator (-D) surged above the green Positive Directional Indicator (+D). This means that the S&P is starting to build up momentum, a negative momentum, as both the ADX and the -D started to trend upward. The market began its downtrend and subsequently declined to the April bottom.
The BUY signal was given right after May 16 when the RSI moved back above 50, the S&P moved above the dotted Parabolic SAR indicator, and the +D crossed above the -D and eventually rose above the ADX - see all blue circles. Then the trending came to a pause in late June and early July when the RSI just hovered around the centerline, the S&P moved sideways, and the +D/-D intertwined with each other going sideways too- see black circles.
Last week, after SELL signal was given when the S&P moved below the Parabolic SAR again in early August, the S&P seemed to have come to another standoff. The RSI stayed flat just under 50 and the +D & -D converged right under ADX. This indicates that the market is currently non-trending BUT with a bearish bias.
The bearish bias stemmed from the fact that the RSI stayed below the centerline, which means there's been more losses in the past 14 days than gains. In addition, the gap between the Parabolic SAR and the price line continues to stay wide open. If the downtrend were to be reversed, the price would've started moving closer to the Parabolic SAR. This is not happening right now. And, then there's +D trending lower while staying below the ADX.
All of these, nevertheless, seemed a little too subtle. Let's see if we could get a verification of this bearish bias from the NASDAQ.
The NASDAQ Composite Index on Chart 2 below shows very similar SELL, BUY, & Sideways patterns in the past. However, last week, the NASDAQ market action appeared to be more bearish than the S&P. The NASDAQ RSI ticked downward rather than staying flat, the -D clearly crossed above the +D, and the -D was also coming awfully close to touching the ADX. A downtrend is confirmed when the red -D crosses above the ADX and starts trending higher.
Finally, let's go outside of Mr. Wilder's analytical world and seek one more downside confirmation on the internal strength of the NASDAQ market. But, before we get to that, I'd like to point out why I'm NOT as interested in the NYSE (New York Stock Exchange).
Chart 2 shows cumulative Advance-Decline issue curves of both the NYSE and the NASDAQ markets. It's not difficult to observe the vast difference between the two. The NASDAQ is much more bearish than the NYSE. This is because the NASDAQ reflects the market status more faithfully than the NYSE. More than half of the NYSE issues are closed-end bond funds, preferred stocks, REITs, and foreign stocks & ADRs (American Depositary Receipts). They may not reflect the actual trend of the stock market.
The NASDAQ Advance-Decline Line is currently falling far and away from its 21-day simple moving average, which represents about a month worth of trading sessions. And, not only that, this 21-day moving average line itself (blue line) had also just started curving downward last week. This should confirm the bearish bias per Welles Wilder's trend identifying tools.
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