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The STORMWATCH Barometer represents the pinnacle of PowerStocks' research efforts to date. It is one of our most reliable, most tested, most flexible, most sophisticated and most profitable trading and investing tools, completely home grown in concept and execution. The STORMWATCH Barometer is an exceedingly ambidextrous breadth indicator. It can:

1. Measure relative intensity of sell-offs and categorise troughs from 1-10
2. Provide superb risk reduction for investor JSE entry through 2 juxtaposing techniques
3. Provide accurate clues for medium and small-trough reversals
4. Stop you from trading in bear markets (we really love this unique feature)
5. Provide an excellent market SHORTING signal (very hard for indicators to do this)

INTRODUCTION
As we have endured various minor pull-backs, more sizeable corrections and downright scary crashes since we have been monitoring the JSE, the question often arises "How big is this sell-off? How serious is this? Is it bigger than the last one? Is it the biggest we have seen?"  It would be nice to measure a current correction in relation to past ones. Just as people are interested in knowing what formalised and standard "Category" of hurricane is bearing down on some unfortunate Atlantic coastline, in order to appreciate its likely effect in terms of damages to property and human life, and to put the news broadcasts into some perspective, it would be nice if we had a similar categorisation for JSE "storms" or corrections.

Conventional wisdom dictated the all-to-easy knee-jerk answer to the above questions : "Well, just measure the extent of the decline." But as some of our longer-term subscribers have come to appreciate, the price of the ALSH index and its daily, monthly and even yearly index movements and trends are poor measures of its underlying strength and health and as such are poor predictors of future direction. As a consequence using price-drop as a guage does not really measure the extent of extremes within the JSE's internals. As we will show later, the occurrence of extremes within the JSE's breadth  internals provide important and accurate fingerprints that can be used by the market timer to very profitable effect.

At PowerStocks Research, market breadth rules our investment decisions. We don't look at the ALSH index's daily published price in relation to yesterday or the last week or month, we look at the advances and declines (both in price and volume) of the individual shares within the index itself. So it stands to reason that we would want to build a barometer that used breadth to depict the intensity of a sell-off or correction. In fact during our research for this project it became quite evident that large price drops in the JSE are not always accompanied by equally intense breadth extremes and vice versa.

INTRODUCING STORMWATCH
StormWatch is a completely original breadth barometer invented by PowerStocks Labs, our research division. It is a barometer that measures volume-breadth with respect to a rolling periods' declining volume versus its advancing volume. The length of the period used and the mathematical formula used to derive the barometer readings are proprietary to PowerStocks Research.

The idea behind STORMWATCH is to provide an indicator that measures selling intensity in a standard fashion so that various corrections over time can be compared relative to one another. The barometer is rated from 0 through to 10 with 10 representing the largest "storm" ever witnessed on the JSE.

Just as the arrival of the eye of a Hurricane provides information to a land observer that the storm is halfway through, or the internal pressure readings taken by a plane flying through the storm provide forecasters with clues on directional movement and further intensity of the Hurricane, there are certain readings (thresholds) and directional behaviour with STORM that provide investors with incredibly insightful information.

The STORMWATCH Barometer as calculated over the last 12 years appears below (right-click and open in new window to see a much larger version. That way you can read our text below and flick back to the larger picture now and again.)



We see that "storms" on the JSE reached Category-10 only once in the 12 year measurement period, in the 2003 crash that eventually launched one of the biggest bull markets in the JSE's history. This is an important first-test of STORM as it is common knowledge that bull markets are preceded by great crashes and there is a correlation between size of the crash and the resulting bull market.

The 1998-2001 bull market was also signalled by a massive Category 8.7, 8.4 and 6.0 "triple-whammy" series of storms. Another massive bull-run was preceded by a Category 8.2 storm in 2001. Our eyes cannot resist to see what happened in the great crash of 2008 and we see to the right of the chart that it registered a Category 6.6 at its peak.

If you look at the larger version of the above chart (you can't see it from here) you will see that trough Mindy, as at 02 Feb 2010, was sitting at category 3, much smaller than Larry which registered 3.8. So despite the fact that Mindy declined 6% and Larry declined 2.5% the barometer showed us Larry was the bigger "sell-off". What this tells us is that Mindy is "likely" to deliver less "bounce" than Larry's 6% growth.

CALIBRATION OF STORMWATCH
StormWatch has been designed to use advancing and decline volume over a certain window period to guage "selling intensity". The way in which it is mathematically constructed ensures that it is not skewed by the growth in volume traded on the JSE over the years. As such, this enables us to calibrate certain consistent thresholds that provide vital clues to the astute investor and trader.

These thresholds are so reliable that it has allowed us to build two superb trade-entry timers called STORM1 and STORM5. STORM1 triggers a BUY alert whenever the barometer goes below 0.92 for at least two consecutive days. STORM5 triggers a BUY alert whenever the barometer goes above 5.0 for at least one day. Both these entry timers offer superb risk reduction for trade entry, but do so based on two entirely different sets of principles. STORM1 enters the JSE when selling is at an all time low. STORM5 enters the JSE when selling is at an all-time high! It is amazing that two such juxtaposed strategies could deliver similar superb trade entry signals.

You will notice there are calibration lines drawn at category 3 and 4. When the barometer touches these lines, goes up over them and then plunges back down through them these are also reliable signals for medium and small trough entry (as opposed to STORM1 and STORM5 which are major correction entry signals.)

A STORM Barometer chart now appears in the PRO Trading Timers sheet of the JBAR report. PRO subscribers will obviously receive daily HeadsUP! alerts when thresholds are met/exceeded and will be able to view the JBAR which is published on Mondays, Wednesdays and Fridays. STANDARD subscribers don't get HeadsUP! alerts but will be able to inspect the STORM chart every Monday with the publication of The Weekly JSE Pulse (WJP). A sample is shown below as at 01 Feb 2010.



We can see that one STORM5 trade entry signal was given on 23rd February, just before the great trough of the 2008 crash hit ground zero. A week or so after the trough, STORM1 tripped a BUY signal. A STORM1 signal after a STORM5 signal is a VERY RELIABLE trade entry point with minimal risk attached. It confirms a major crash-class sell-off followed by a buying orgy - the classic fingerprint of a major trough.

There were also several more STORM1 trade entry signals as the barometer dipped below the black line on the bottom as the JSE marched on its way upward.

Other excellent clues coughed up by the indicator were various minor trough reversals when the yellow line (a moving average of the barometer) punched through 3 and fell back through it again. You can see that for Mindy, (extreme right hand side of the chart) the barometer broke through 3 and its yellow average has now reversed and about to plunge below 3 again, signalling a BUY signal for Mindy.

STORM-1 and STORM-5 Trade Risk Reduction Entry Signals
If you recall, STORM-1 issues a BUY signal when the barometer drops below the black line at the bottom of the STORMWATCH chart, for at least 2 consecutive days. These events are marked by exceptionally low selling pressure which occur 9 times out of 10 when a buying orgy follows a selling panic. The signal tells us that "sufficient extraordinary buying intensity has entered the market to propel it higher for some time to come." It can be scary trading this signal since it normally tells you to buy after the market has already made a substantial move upward. It is daunting to commit to the markets when it has made a huge run, but as we will show, this is an excellent strategy from a risk and return perspective.

STORM-5 takes a completely different tack. It looks for extremes in selling intensity and says :"This is extreme selling. It's a fire sale and I'm going to snap up what everyone else is dumping on the market. This is selling at any price and I am going to be there to pick up what's been discarded by silly sellers as history has taught me the pendulum will soon swing from this extreme to the other in a short space of time." Acting on a STORM-5 signal is more scary than acting on a STORM-1 signal. At least with STORM-1 the buyers are flocking back and you're not in the minority, but with STORM5 you are probably one of only a few buyers in the market! But amazingly this strategy works exceedingly well, even better than STORM-1. But you need guts, it is not uncommon for the market to continue a mad slide shortly after you have entered a STORM-5 trade and it will take all your reserves to keep your head about you whilst everybody else seems to be losing theirs!

The STORM-1 and STORM-5 trade entry statistics are displayed below together with another highly successful market entry strategy from our Lowry's research to allow you to compare.



"Days" represents days after the signal fired.
"Win" represents how often a trade generated a profit.
"Avg" is the average profit per trade.
"Sharp" is the average trade profit divided by the standard deviation, which is a measure of how "consistent" the returns were (low numbers below .25 are bad, numbers above 0.5 are good.)
 "gn/l" is the gain to loss ratio which tallies up how many percentage points were gained in the winning trades and divides this by how many losing percentage points were made during the losing trades.

We see that STORM-1 generated 55 signals, or 4.58 signals per year (once every 2.6 months). The optimal short-term holding period is 40 days which has an excellent 9:1 gain/loss ratio (9 percentage points gained for every point lost.) and a 81.8% success rate. STORM-5 was far less frequent but with an incredible 13.5:1 gain-to-loss ratio for 40 day holding periods, even with its lower 76.5% success rate. Both strategies have very good Sharpe ratios above 0.8. As you can see, both strategies come close to the most successful strategy we have seen to date which is the Lowry's 90up/90dn entry strategy.

STORM-1 HISTORICAL BUY SIGNAL CHART
Whilst the average returns in the table in the previous section look small, you must remember we are dealing with averages over a large number of trades and many trades are in the +10 and even plus 15% profit ranges over short periods. The true power for these signals can only be appreciated when viewed against the backdrop of the JSE to show you what superb market timing they offer. Right-click to open larger versions of the below charts in a new window so you can flick between this text and the image if you need to.



Upon further inspection of the above chart it jumps out at you that STORM-1 keeps you buying in the bull markets and goes quiet in the bear markets! It is a rather incredible feature of this strategy, to keep issuing "its safe to buy now" alerts and then suddenly cease when the JSE is coming up to a crash or a period of sideways movement where you would probably be better of in cash. Look at the extended blank periods above to see how uncanny this is.

Of course, the one problem with this strategy is that the last signal it issues before the bear market is a BUY signal related to the "blow off" typical of major tops so one has to be careful when timing with this signal and ensure the PowerStocks LBYC and SUPERModel investment timing signals are giving the all clear.

Another strategy is to stop trading STORM1 signals after your first losing trade. If one started trading the first STORM1 signal after an extended bear market and then with each subsequent signal allocated more and more cash to the market, then this loss at the end is likely to be a small one compared to your overall holdings already in the market and your first clue that perhaps you should be offloading all your holdings from the market.

The next question likely to come to your enquiring mind is "But how much better did STORM-1 fare than a strategy that just traded 55 times at frequent intervals over the 12 years?" The strategy of investing frequently in the market is called "Dollar Cost Average Investing" and is often hailed by many people as the best option for novice investors. However we have shown that if one took one's cue from the STORM-1 BUY signals as opposed to regular intervals, that your gain/loss ratio would be boosted by a factor of 4! To see these details read "Dollar Averaging with STORM-1".

STORM-5 HISTORICAL BUY SIGNAL CHART



Whilst this strategy is good at picking out troughs that precede bull markets, quite a few of the signals are before trough ground-zero and you would probably be better off delaying the trades by 3-4 days to improve gains.

Despite a bias toward getting in a little early this strategy still manages to out-perform STORM1. It is quite feasible that when this signal sounds, you are given an advance warning the trough is near and can start looking for TroughFinder B-signals (even if they are weak ones) and this should substantially improve the timing and boost returns. Do not wait for the barometer to stay above 5 for multiple days though, quite often it hits 5 for only one day (it is after all, an extreme event.) and by doing this you will miss half the signals.

SHORT-SELLING THE JSE
The fifth useful function of the STORM Barometer is an infrequent (once per annum) but reliable shorting signal. The characteristic of STORM-5 to fall a bit more before the big bounce got one of our astute subscribers wondering if something was lurking in there what would allow a good confidence shorting strategy. After a bit of digging we stumbled across something.

With easy to trade warrants to short and long the market these days, it is no longer difficult for the private investor to place a quick bet on the JSE falling without having to go through a complex process of borrowing script etc. However it is normally very difficult to build a reliable and frequent mechanical signal system to provide short signals. This is because market tops are long drawn out affairs whereas troughs are violent rapid affairs.

However it would seem that if you waited for the STORMGUAGE to strike over 4.6 for more than 2 days and then immediately  shorted the JSE index, you would have a system that worked 10 out of 11 times over the last twelve years for a 5-day short-trade. We have dubbed the strategy STORM46SHORT and its trade statistics appear below:



You can see this strategy, if you acted quickly enough with a geared warrant of say 10 times, would provide a 10%to 62% gain on its "winning" trades, and a single loss of 19% resulting in an incredulous gain/loss ratio of 178.63! The very high Sharpe ratio tells us these are consistent gains (they do not vary wildly) and you can see this by comparing each trade yourself in the above table.

The strategy is good for STORM-GAUGE threshold figures ranging from 4.55 (gain/loss of 14:1) through to 5 (gain/loss of 8:1) but works best as shown at 4.6. The strategy is also good for 3 days (gain/loss of 34:1) and 4 days (gain/loss of 149:1) but on 6 days the gain/loss plunges to 5:1 and rapidly deteriorates thereafter. Because you will be playing in a rapidly falling market, bid-ask spreads should work in your favour if you ensure you get in early and pull out before the 5 day ends.

BUILDING STORM5+
The reliability of STORM46SHORT tells us that when the STORMGUAGE gets beyond 4.6 and most likely shoots to above 5 (as is normal for a panic driven sell-off) that STORM5 would be better waiting a bit before piling into the market. We configured rules that did exactly that into our back-tester and it made a significant difference to STORM5's performance. The new strategy we will call STORM5+

STORM5+ goes on alert when the STORMGUAGE exceeds 5, but rather than trading straight away, waits until the guage falls to below 3 before pulling the BUY trigger. When the guage has fallen to 3 it is a sign that panic selling has abated and offers a superior entry point. Using this new rule, STORM5+ offers far superior short term trade (5-30 day) performance (win/loss ratios) as shown below:



We see that for 5, 10, 20, 30 and 40 days trade lengths that STORM5+ offers kick-ass gain/loss ratios and win-rates over the older STORM. The 30 and 40 day gain/loss ratios of 29.4 and 26.5 are simply staggering. Even the 5-day gain/loss ratio of 5:1 is superb and the best we have seen of any of the timing strategies. This is obviously due to the strategy timing the troughs better and eliminating its older premature trigger. Over 50 days though, both strategies offer similar performance.

DOUBLE-TRADING STORM5
So here is the double-trade strategy. When the STORMGUAGE remains above 4.6 for at least two days within a 5-day trading-day window period (don't count weekends and holidays) you short the JSE immediately. Then after 5 days, you close or cover the short. If during the short trade the guage hit over 5, even for one day, then when the guage drops to below 3 you immediately go long the JSE.

This lets you capitalise on that high confidence  last drop before the market bounces and ensures when you go long STORM5+, its all up from there! Double trade, double profits!

STORM TIMING SIGNAL CHARTS ON JBAR
Subscribers get to view the STORM1 and STORM5 timing charts in the PRO TIMERS sheet in the JBAR report. They are presented in the same format as all the other timers such as SWISSCLOCK and the BITS family of timers:



STORM5+ is an excellent investing signal for risk-reduced JSE entry and for that reason we do not trade it with set time intervals as with our other timers, we merely show where it triggered BUY signals. STORM1 will likely be popular with our shorter term traders due to its frequency of signals and so we track the 40-day forced-exit version of it (which has the highest gain/loss ratio in the 12 year backtests).

But remember STORM1 is good for any holding period as its purpose in life is to continually signal bullish periods in the JSE where it should be safe to enter. As such it is excellent for investors who put away regular amounts in the JSE (use the JSE as a savings scheme)

SEE STORM PUT TO USE  --> | Dollar Cost Average Investing with STORM-1 |
 
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