My apologies for the late entry today.
In this blog, I’ll be comparing Katsonos’ Congestion Index to the Barros Swing. The great thing about the Congestion Index is it captures all the advantages and disadvantages of trend identifying technical indicators in one tool and in a simple way. It seeks to measure the market’s structure “by dividing the actual percentage that the market has changed in the past x days by the extreme range according to the formula:
{ (C-C[X-1])/C[X-1]}/{[HIGHEST(H,X) - LOWEST (L,X)]/LOWEST (L,X)}
where C is the closing price, X is the time segment; and Highest and Lowest are the highest high and lowest low respectively for the chosen period X.” (Intermarket Trading Strategies, page 140). The quotient from Congestion Index formula above is then smoothed by a 3-day exponential moving average.
The ideas are:
- The Congestion Index fluctuates between 100 and -100. The closer to 100, the greater the ‘trendiness’ (i.e. the less congested) of the uptrend; the closer to -100, the greater the ‘trendiness’ of the downtrend.
- Crossing from below to above the 20 reading identifies the start of an uptrend; crossing from above to below the 20 line identifies the start of a downtrend.
- Readings between +20 and -20 identify correction or congestion modes.
- Historical extreme readings identify overbought and oversold. Note that Katsonos uses +85 to 100 and -85 to -100; but experience acquired in a different life suggests that historical rather than a fixed number provides for more robust trading.
Figure 1shows the current Shanghai Index. Note that:
- The black line represents the quarterly trend
- The red line represents the 18-day swing (monthly trend)
- The blue line represents the 18-day swing (weekly trend)
- The red indicator is a 28-day Congestion Index
- The green arrows show false trend changes i.e. the market resumed the downtrend shortly after the signal (a bear trap).
- The orange arrow shows a valid trend change signal
- The brown rectangle shows congestion/correction readings compared to the price action.
FIGURE 1 CI and Barros Swings Shanghai Index
Let’s start the comparison by recalling that traditionally downtrends are a series of lower lows and lower highs. I amend the definition by incorporating the word ’swing’: downtrends are a series of lower swing lows and lower swing highs. I do this to incorporate the idea of time frames; this is needed to account for the breach of lower lows when the trader’s timeframe corrects with the result that the next lower time frame at least attempts to change its trend.
In Figure 1 note that each time the red line turned up, the blue line broke above its previous high. Imagine that you are trading those upswings real-time. You need an indicator to tell you if the up turn is merely a correction in an ongoing uptrend or change in trend in your time frame. Even if the overall downtrend remains intact, the difference is crucial because a correction in the trader’s timeframe will denote a contra-trend move of a far lower magnitude in price and probably time than a change in trend in that timeframe.
For example In Figure 1, the largest correction has been 26.19%; Since this is a quarterly trend correction, I would expect the correction to be greater in price (so far 27.05%) and probably in time (the largest time correction is 31 bars; so far this up move is 23 bars). In addition, since this is a quarterly correction, the retracement would be off the all-time high in Oct 2007.
On Friday evening, I’ll conclude the series by comparing the Barros Swing signals with that of the Congestion Index.
Refer this blog post to a friend or colleague…
