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Using the Z-Trend Oscillator for Long-Term Bond Market Timing

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Using the Z-Trend Oscillator for Long-Term Bond Market Timing Using the Z-TrendOscillator for Long-Term Bond Market Timing 6 Submitted by Robert T. Zukowski, CMT March4. 1996 Overview Because it reflects mass psychology, the Coppock Curve is labeled by tnost technicians attd traders as a setttimettt This paper examines the concept of modifying the indicator. As a result, the curve siguals market tops and Coppock Curve to better identify major tops attd bottoms bottoms quite well and proves to be a valuable addition to in the bond futures market for lottg-term positioning. The atty trader’s tool kit. Coppock combined art 1 l- and 14 modified versiott of the Coppock Curve is referred to as mouth ROC, smoothed over by a lo-tnottth weighted mov- the Z-Trend Oscillator. Most oscillators are used for trad- ing average, which cat1 be explaitted by the yearly titne ing periods of price consolidation, but the Z-Trend Oscil- cycles frequent in tnost tnarket indices. A buy signal oc- lator is specifically used for trading all market cottditiotts curs when the curve turns up or becotnes positively sloped from accumulation, to trending, to distribution. while below the zero litte. A sell sigttal occurs when the curve turns down or becomes negatively sloped while Introduction to Rate of Change and the above the zero line. Coppock Curve Otte of the older, sitnpler tcchttical ittdicators to un- The Problem - Indicator Consistency derstand is the rate of chattge or ROC for short. ROC catt When the Coppock Curve is applied to the monthly confirm tnarket trends and forewarn of market reversals. continuation chart of U.S. Treasury Bottd future prices The ROC tneasures the pace at which price is chattgittg (UST’s) , traders are confronted with the probletn of indi- for any titne period under study. For example, a lo-da) cator consistency. This tneatts that the cottfidettce level ROC is calculated by subtracting the price today from the for each future buy/sell signal is significantly reduced be- price 10 days ago. The result is thett plotted as a cotttinu- cause the ittdicator’s extremes or overbought/oversold ous series that oscillates above and below att equilibrium levels vary frotn sigttal to signal. Notice how well chattges level that is usually set at 0. The closittg price is getterall! in the curve coincide with each major top attd bottom in used whett calculatittg the ROC. However, the ROC cat1 UST’s (see chart 1). Again, the problem is that the ittdi- be altered to isolate volume attd other ittdicators such as cator does ttot offer a high level of consistency for future moving averages. Trettdlitte analysis and indicator/price buy/sell signals. In other words, traders are not sure how divergettccs arc other aspects of the ROC that catt be used low or high the indicator will go before a signal is given. to enhance reliability. With this kind of versatility, traders can mattipulatc the ROC itt mattv useful ways. Edwitt S. Coppock, best kttowtt for the developtnettt of the Coppock Curve, used ROC as the basis for his work. First introduced in Barrott’s itt 1962, the Coppock Curve was ettdorsed arouttd the world as a long-term ittdicator used to forecast foreign and domestic equity markets.’ The goal of Coppock’s tnometttum rvork is to smooth a price series in such a way as to make the peaks attd troughs in ROC data significant. Smoothed mometttum (referred to as the Coppock Curve) looks attd acts much like a sitte curve or an overbought/oversold oscillator as it moves from positive (overbought) territory to negative (oversold) territory attd back again. Coppock hypothesized that the market’s emotional state could be determined by addittg up the percetttage price chattges for the time period uu- der study to get a settse of tnarket tnometttutn. The result is a long-term curve that effectively measures tnarket mo- mentum and filters out short-term attd intermediate-term tnarket swings. ‘Dudnrk, Gail S., C,IfT, SbfP Group dnnlyis ,\,Jonthly Briejng (Feb. 1996), p 4. MTA ~OCRML !Sprin+mmer 1996 49 useful. It maintains a long-term position during a side- ways trend by decelerating as the market’s price ranges become more narrow. (3) The buy/sell equation is writ- ten by combining the slope of the indicator with over- bought/oversold extremes to determine if a profitable trade exists (see table 1 for calculations). TABLE 1 Calculations: Z-trend Oscillator in Computrac Snap version 4.2 - coef: coef 6. study: rt-chg rt-chg(close, coed)-100 [see below] L coef: coef2 8. [z-tnagsc au-aug study: I-t-chg2 rt-chg(close, coef2)-100 [see below] user: sum-rot rt-chg t rt-chg 2 coef: coef3 10. study: wtd-ma \vtd-ma (sum-rot, coef3) studp: rsi rsi(wtd-ma, 10) user: z-trend-osc (2 * rsi)-100 studv: mov-avg rnov-avg(z-trend-osc, 5) user: buy (z-trend-osc > z-trend-osc [l] & That could lead to the wrong position in terms of timing, z-trend-osc < -40) (see chart 2). 111chart 2, two examples of false signals user: sell (z-trend-osc < z-trend-osc [l] SC that resulted in big lossescan be seen in June 1980 and -trend-osc > 50) January 1992. Basically, the curve failed to keep traders user: sold sell * .5 in a long-term position during these periods of price ac- trade: trade trade(buy, sell, sell, buy) tion. trade: open-p1 open-pl(trade, close, j/32, 2/32) trade: trad-pl trad-pl(trade, close, 5/32, 2/32) The Solution - Modifying the Coppock Curve trade: clos-pl clos-pl(trade, close, 0, 0) By modifying the Coppock Curve, traders can isolate user: equit) open-p1 t clos-pl overbought/oversold conditions and buy/sell signalsmore [Note] - 1st step selert and add the rt-rhg study in snup. 2nd step: effectively. The added value is a high performance mo- manually edit the rt-rhg stud) 6~ tJjb]g in -100 mentum oscillator with fixed buy/sell zones. The Z-Trend There are four advantages to using the Z-Trend Oscil- Oscillator uses the same basic calculation as the Coppock lator over the Coppock Curve: (1) It is smoother and less (;urve. but has a few added dimensions. (1) The indica- volatile, (see chart 3 for a comparison). (2) The ampli- tor is optimized wily OI~C time and then back tested to tude is controlled through the modified version of the lind optimum KOC and smoothing periods. Interestingly, CHART 3 us Boms-mmi C3rr:mT:oH the ROC part of the indicator when optimized coincided \\ith the 2 l-week cycle, and the weighted moving average portion coincided with the 40-week cycle, much like the yearly cycles Coppock found in most equity markets. Both the 21-week and 40-week cycles were popularized by Jim E. Tillman, CMT, of Interstate/Johnson Lane, and are fre- quently used in forecasting turning points in UST’s. (2) The indicator uses the concept behind J. Welles Wilder’s Relative Strength Index (RSI) to identify overbought/over- sold conditions. III other words, the Z-trend Oscillator is a11 RSI study of the Coppock Curve. First, the raw num- bers of the Coppock Curve are substituted for the usual closing price within the RSI calculation to normalize it on a scale of 0 to 100. Second, this modified version of the coppocx RSI is multiplied bv itself and then subtracted from 100 to make it oscillate above and below 0 and between defined Lanes. A&l example of defined zones would be between -70 and 70. This will identifv proxies of overbought/over- sold. Once that is accompli&ed, buy/sell signals become more visible. This is where the Z-Trend Oscillator becomes 50 MTA ~OUIWWSptin~-Summer 1996 RSI formula. (3) Major buy/sell signals become more visible. (4) Overbought/oversold zones are identified. The only disadvantage noticed is: (1) It is iueffective when used over shorter time periods such as weekly, daily arid intra-da): Using and Customizing the Z-Trend Oscillator A buy signal occurs when the Z-Trend oscillator (this month) is greater than it was (last month) and is less than -40. A sell signal occurs when the Z-Trend Oscillator (this month) is less thau it was (last month) arid is greater than .iO. Lead time is significantly increased over using CHART4 3s BONDS-ncNTHLYc3h7m*~:~?l I Ius -, -n hue Iz-tnd-osc lou-aug ,/!a19 Uuill Hod3 hri% dul88 NouSEkar9 Ai?5 1 5). From September 1982 to Jlarch 1983, the UST mar- ket was considered extremely overbought, which was eli- dent by an indicator reading of greater than 70. That was a waruulg sign suggesting traders should start looking for a new sell signal. In fact, the signal was giveu in April 1983 when the indicator began to decelerate while still above the trigger level set at 50. The result wasa 1Gmonth trade Ccldiug 12.69 points. From September 1987 to So- vemb& 1987, the Z-Treud Oscillator rcachcd a rcadiug of lessthau -70, which warned of a potential market reversal from down to up. This oversold rcadiug bcgau to unwind Coppock’s original bu~/sell strategy (see chart 4). X more in December 1987 when the indicator touched the bul couscrvative buy/ sell approach would be to wait until the trigger level set at -40. The result \va?sa 24-mouth trade indicator crossed above or below the 0 line. However, the for 10.25 points. Lero lille trade reduces profit and iucreases risk because Other examples of the Z-Trend Oscillator iI1 action ca11 siguals occur well after a top or bottom has beeri com- be sew during 1983, 198.5, 1988, 1991 alld 1994.
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