The Opening Bell Newsletter

is a publication of AIQ SystemsP.O. Box 7530Incline Village, Nevada 89452

In This Issue

New +/- DMI indicator inTradingExpert Pro 7.2 canhelp avoid whipsaws ........ 1

Market Review:AIQ's market timing signalsfor month of October arereviewed ........................... 3

Percent to Double, a usefultool for option traders, isexplained.......................... 4

David Vomund tests his"Relative Strength Reportstrategy" on Select SectorSPDRs. Here are theresults .............................. 6

Data Maintenance ............ 8

AIQ's TradingExpert Pro7.2. upgrade contains newfeatures and tradingstrategies that AIQ usershave asked for ................. 8

S&P 500 Changes: Thereare no changes this month.

Opening BellNewsle t t e r

AIQ

“The +/-DMI can be used either as asystem on its own or as a filter for

a trend-following system…To makesure that you only act on signals inthe direction of the trend, then onlyact on signals that agree with the

+/-DMI signals.”

New DMI Indicators

Avoid Bad Whipsaw Signals! Try UsingTradingExpert's New +/- DMI FilterBy David Vomund

DAVID VOMUND

November 2003 Vol. 12 Issue 11

n the new 7.2 release of AIQ’sTradingExpert Pro there is anew indicator called +/-DMI.AIQ users have requested thisindicator because it is often

found in technical analysis books.Interestingly, the +/-DMI is not really anew indicator in TradingExpert. In-stead, it is a different method of chart-ing the Directional Movement Indicator(DMI). Let me explain.

Directional Movement is a conceptthat J. Welles Wilder, Jr. described in hisbook, New Concepts in Technical TradingSystems. The DMI is basedon the assumption thatwhen the trend is up,today’s price should beabove yesterday’s high.Conversely, when the trendis down, today’s low priceshould be lower thanyesterday’s low.

In calculating the +/-DMI indicator, whentoday’s high is greater thanthe previous day’s high,then the difference in the upwardmovement is the +DI. When today’slow is less than the previous day’s low,then the difference in the downwardmovement is the –DI. Inside days areignored.

I The +DIand –DInumbers arethen averagedfor a period ofdays (thedefault is 14)and thendivided bythe averagetrue range.The resultsare normalized and displayed as oscilla-tors.

Figure 1 shows a chart of TexasInstruments. The bottom of the chartdisplays the new +/-DMI indicator. Ifthe +DI is above the –DI, the directionalmovement is up. If the +DI is below the–DI, then directional movement is

2

AIQ Opening Bell November 2003

March 2002

“Another Welles Wilder indicator isthe Parabolic system (ParaSAR). This

indicator works great in trendingenvironments but whipsaws duringsideways movement. Many of the

whipsaws can be eliminated bycombining the ParaSAR indicator

with the +/-DMI.”

down. The greater the differencebetween the +DI and –DI, the moresignificant the trend. For this indica-tor, a buy signal is registered whenthe +DI crosses above the –DI. A sellsignal is indicated when the +DI fallsbelow the –DI.

The Directional MovementIndicator (DMI) is simply the differ-ence between the +DI and –DIindicators. Comparing the DMI tothe +/-DMI in Figure 1, we see thatwhen the +DI crosses above –DI, theDMI rises above zero. When the +DIis well above –DI, as it was in lateAugust, the DMI is very positive.The point is that these are the sameindicators charted differently.

Why has AIQ added the +/-DMIindicator? One reason is to satisfyuser requests. Many technicalanalysis books plot the +/-DMIindicator instead of the DMI. Trad-ers wanted their systems to resemblethe technical books. Another reasonis that more advanced users wanted

to run studies on just the +DI line.That is not possible when using theDMI.

The +/-DMI can be used eitheras a system on its own or as a filterfor a trend-following system. Trendfollowing systems often turn intowhipsaws during non-trendingenvironments. To make sure thatyou only act on signals in the direc-tion of the trend, then only act onsignals that agree with the +/-DMIsignals. Let me explain with anexample.

Another Welles Wilder indicatoris the Parabolic system (ParaSAR).

This indicatorworks great intrending envi-ronments butwhipsawsduring side-ways move-ment. Many ofthe whipsawscan be elimi-nated by com-bining theParaSARindicator with

the +/-DMI. Here is how it works —only act on ParaSAR buy signalswhen the +DI is above the –DI.Along the same lines, only act onParaSAR sell short signals when the+DI is below the –DI.

Figure 2 shows a chart ofTextron Inc. (TXT). On the pricechart is the ParaSAR indicator. Thisindicator gets its name from theshape assumed by the trailing stopsthat tend to curve like a parabola.Notice that as prices trend higher,the rising dots below the price

action, which represent the sellpoints, tend to start out slower andthen accelerate with the trend. Abuy signal occurs when prices riseabove the downtrending dots.

Figure 2 shows seven buy signals(see arrows on price chart). Duringthe same period, the +DI only roseabove –DI three times (see arrows onDMI indicator). The ParaSAR isclearly a more sensitive system.

Figure 1. Daily chart of Texas Instruments. Displayed below the price are the DirMov (DMI) andthe +/-DMI indictors. Note the similarity between DirMov and the new +/-DMI indicator.

AIQ Opening Bell NewsletterDavid Vomund, PublisherG.R. Barbor, Editor

AIQ Opening Bell does not intend tomake trading recommendations, nordo we publish, keep or claim any trackrecords. It is designed as a serioustool to aid investors in their tradingdecisions through the use of AIQsoftware and an increased familiaritywith technical indicators and tradingstrategies.

While the information in this newslet-ter is believed to be reliable, accuracycannot be guaranteed. Past perfor-mance does not guarantee futureresults.

© 1992-2003, AIQ Systems

3

November 2003 AIQ Opening Bell

Figure 2. Daily chart of Textron with DirMov (DMI) and +/-DMI indictors. ParaSAR indicator hasbeen added to price plot and arrows drawn to show ParaSAR buy signals. Note that +/-DMI gaveonly three buy signals during same period that ParaSAR gave seven buys.

By using the +/-DMI filter,several of the bad whipsaw signalsin the ParaSAR indicator wouldhave been avoided. DirectionalMovement is positive from Maythrough August so during thisperiod only ParaSAR buy signalsshould be acted on. ParaSAR short-selling signals should be ignored.Using this technique, you onlytraded in the direction of the trendand two whipsaws were avoided.

Most people will continue to plotthe DMI indicator instead of the+/-DMI because it is easier to spotcrossovers. However, adding the+/-DMI indicator gives you theflexibility to experiment with thecomponents that make up the DMIindicator.

Market Review

David Vomund publishes VIS Alert, aweekly investment newsletter. Forsample issues, visit www.visalert.com.

ctober is supposed tobe a “scary” month forthe market. Thatwasn’t the case thisyear. Helped by

strong economic and earnings news,the S&P 500 rose 5.5% in October.Even stronger were small-cap stockswith the Russell 2000 gaining 8.3%.The good news was punctuated by avery strong Gross Domestic Product(GDP) number. Third-quarter GDPgrew at a sizzling 7.2 percent annualrate, the fastest since 1984.

Several of the top performingindustry groups in October werecommodity related. Metals Miningrose 20%, Aluminum rose 18%, Steelrose 17%, and Forest Products rose17%. Not all groups participated inthe rally. Food Retailers lost 8%,Wireless Communications lost 6%,and Oil & Gas Services lost 6%.

Market averages have been verystrong since the March lows. Thebest trendline is found on theNasdaq Composite (Figure 1). TheNasdaq has touched this trendline

on four separate occasions (seearrows). As long as the Nasdaq isabove this trendline, the bullishpattern is intact and oversold buy

O

signals will work better than over-bought sell signals.

Figure 1. Daily chart of Nasdaq Comp. with support trendline that has been tested (arrows) butnot penetrated since early March.

4

AIQ Opening Bell November 2003

March 2002

Option Analysis

'Percent to Double'A Useful Tool for Option TradersBy Stephen Hill

Option traders have asked AIQ toinclude the parameter Percent to Doublein its popular OptionExpert software.This tool is used to establish realisticgoals for option trades.

If you trade options, you’veprobably heard the term“Percent to Double.” Thequestion is, what exactly isPercent to Double? Why

not Percent to Triple? I decided toask the experts.

I contacted the pros at the CBOEand CME and asked: what is Percentto Double? A friendly supportperson at the CME referred me to anarchived answer (obviously, thisquestion has been raised before).The following paragraph is a para-phrased version of the archivedanswer to my question.

….”Percent to double” is notcommonly used in the U.S., althoughit is used in Europe and the U.K.“Percent to double” is the percent-age price rise needed in the price ofthe underlying for the option todouble in price on the option’sexpiration date. The theory is that,the lower the Percent to Double, thebetter. Note, however, that for anystrategy to work, the forecast for theunderlying stock must be accurate…

I would disagree with the “notcommonly used in the U.S.” state-ment.

Here’s an example of Percent toDouble:

Consider that the price of XYZstock is $58 and the price of the XYZMarch 60 Call is 3.50. At a stockprice of $67 on the day Marchoptions expire; this call will have a

value of 7.00, or double the currentprice of 3.50. A stock price rise from$58 to $67 is an increase of 15.5%(approximately), so that is the“Percent to Double” in this example.

That’s the theory. But you’llnotice that this explanation is a littlelight on details, plus the reference tothe Europeanstyle optionswith price onexpiration.European styleoptions areoption con-tracts that maybe exercisedonly during aspecifiedperiod of time just prior to theirexpiration; American style optionscontracts may be exercised at anytime between the date of purchaseand the expiration date.

How is Percent to Doublecalculated?

The answer relies heavily on thetype of formula that is used todetermine fair value of any givenoption given a specific set of circum-stances. The most common model

used to determine fair value ofoptions is the Black-Scholes analyti-cal model. The Black-Scholes modeldetermines a fair price of an optionbased on a set of conditions whichinclude such factors as time toexpiration, interest rates, volatility ofthe stock, and the option strike price.

In computing Percent to Doublethere are 5 elements of informationrequired. These are listed in Table 1.

The first two elements are givenwhen we decide to open an optionposition. The price of the option atthe given future date is also straight-forward; it’s twice the opening valueof the option. Essentially, we havealready determined a value of theoption on the given date. What weneed to determine is the value of theunderlying that matches that option

I

Table 1. Percent to Double input requirements

• Today’s underlying price.

• Today’s price of the option.

• The future date for analysis.

• The underlying price at the future date.

• The price of the option at the future date.

“There are some resources on theinternet that offer Percent to Double as

a service. Fortunately, AIQ’sOptionExpert offers us an easy way to

calculate Percent to Double.”

5

November 2003 AIQ Opening Bell

value. To achieve this, the Black-Scholes formula needs to be resolvedbackwards.

Doing this by hand would bevery time consuming. There aresome resources on the internet thatoffer Percent to Double as a service.Fortunately, AIQ’s OptionExpertoffers us an easy way to calculatePercent to Double.

When evaluating options on agiven underlying, by defaultOptionExpert fixes the analysis dateto the next expiration. If we arewithin 10 days of next expiration, thedate moves out to the next month.

The value of the underlying onthat expiration date is also deter-mined by using a modified slopeformula based on work undertakenby Larry McMillan. However, thevalue of the underlying at expirationdetermined by OptionExpert is notgoing to match the value of theunderlying we are looking for, but itdoes fix the parameters for us tomove to the next step in the calcula-tion.

Let’s look at an example thatshows how we can use OptionExpertto find the value we need. Figure 1displays data for a straight buy of 5contracts of Yahoo (YHOO) Dec’0340 Puts at 1.85. Immediately wehave two of our requirements, thecurrent value of 1.85 and the value ofthe option at double the currentprice or 3.70.

Other information in Figure 1includes the value of the underlyingtoday (42.27), date for analysis (inthis case November ’03 expiration of11/21/03) and an indicated value forthe underlying on that date of 35.The question is, how do we deter-mine the value for the underlying onthe analysis date that correspondswith a doubling of the option value(given that all other factors remainthe same)?

Fortunately, OptionExpert hasseveral different graphical represen-tations of any given option. For ourpurposes, we will use the price of the

Figure 1. Situation Data section of OptionExpert's Position Analysis screen. Data in left panelincludes current price and volatility for Yahoo stock and a projected value of 35 on 11/21/03. Theposition data section lists a straight buy of 5 contracts of Yahoo Dec'03 Puts at price of 1.85.

Figure 2. Position Graph section of OptionExpert's Position Analysis screen. Plot displaysrelationship between option Value (vertical axis) and stock Price (horizontal axis) computed for theanalysis date of 11/21/03.

Figure 3. Position Graph with annotations showing how the Stock Price corresponding to thetarget Option Value of 3.7 is easily found. To locate the exact value, move the crosshair along thecurve. Notice values that appear on each axis to show exact coordinates of the crosshair position.When the value scale reads 3.7, the number shown on the Price scale (36.6) is the correspondingstock price.

6

AIQ Opening Bell November 2003

March 2002

Incorporating the Style Index Approach to Sectors

Testing Our 'Relative Strength Report Strategy'Using Select Sector SPDRsBy David Vomund

ast month we discusseda trading approach thattook advantage of theRelative Strength reportand applied it to Ex-

change Traded Funds (ETFs) thattrack various market indexes. Nowwe’ll apply the same approach toindustry sectors to see how well itspots sector rotation.

For our sector trading test, wecould have used sector funds fromwell known mutual fund families.The most popular choice would beFidelity Investments. Fidelity’s 40sector fund choices give Fidelity thebroadest selection compared tocompetitors. Making the sectorfunds more attractive, Fidelity hasjust lifted the 3% sales load (that’sthe good news about a bear mar-ket—products become more afford-able!). Fidelity does charge a pen-alty if you hold a fund for less than30 days, however. Information onFidelity sector funds can be found at

Figure 1. Relative Strength (Strong) Report for October 3, 2003. The report, run on a list ofeight SPDRs (sector ETFs), shows the Technology and Utilities sector funds in top positions.

L

underlying versus value graph (seeFigure 2).

To determine the price theunderlying needs to attain for thevalue of the option to double,OptionExpert utilizes a crosshairthat allows us to pinpoint thisposition on the price/value curve.Figure 3 illustrates this point. Thecorresponding value of the underly-ing for an option value of 3.7 is 36.6.

Finally, we need to run a quickcalculation to determine the percentchange in the underlying thatbrought about the doubling in value

of the option. We'll use this formula:

PTD = V2 - V1 x 100

V2Where:

PTD = % to Double

V2= Value of underlying onanalysis date

V1 = Value of underlying onacquired date

Plugging in our example values:

PDT = 36.6 - 42.2 x 100 36.6

PDT = -15.3%

To sum up this example, for theDecember ’03 40 put on Yahoo todouble its value from the acquisitiondate to the analysis date, the under-lying ticker must fall by 15.3%.

How would an option tradermake use of the Percent to Doubleparameter? The first step is to take alook at the historical chart of theunderlying security to determinehow realistic it is for the value tochange by the indicated percentagein the time frame used in the evalua-tion. If it appears unlikely, then youknow that the upside potential of theposition is limited.

www.fidelity.com.The Rydex family of mutual

funds also offers sector fund choices.

With 17 funds, Rydex doesn’t offerthe selection that Fidelity does, but ithas the ones that count the most.

Percent to Double (continued)

7

November 2003 AIQ Opening Bell

“For our study we decided to use theSelect Sector SPDRs…These sectors

can be bought or sold at any timeduring the trading day in the same

manner as buying shares of stock. Youcan even sell them short.”

transaction is placed, shares can becreated or redeemed to meet de-mand.

The StrategyOur trading strategy utilizes

AIQ’s Relative Strength report. TheShort-Term Relative Strength-Strongreport was run every other Friday onthe SPDRs.This reportlooks at the last120 tradingdays (approx.six months)and breaksthem intoquarters. Apercentagereturn figure iscalculated foreach quarter. These returns are thenaveraged with twice the weightplaced on the most recent quarter’sworth of data.

At the start of the test, the twohighest ranked ETFs were purchasedwith equal dollar amounts to estab-lish a fully invested portfolio. Twoweeks later, the Relative Strength

report was run again. If the currentholdings were rated in the top half ofthe report, then there were no trades.If a holding had fallen in the RelativeStrength report to where it was nolonger in the top three, then it wassold and the highest rated ETF waspurchased. The portfolio wasalways fully invested in two SPDRs.

The strategy is designed to rotate tothe sectors of the market that havethe best performance.

Figure 1 shows the RelativeStrength report on October 3, 2003.Since we are examining eight SPDRs,as long as our portfolio holdings arewithin the top four of the report thenthere are no trades. XLI and XLK

The advantage of Rydex funds is freeunlimited trading. Information onRydex sector funds can be found atwww.rydexfunds.com.

Rather than using mutual fundsto trade sectors, you can also useExchange Traded Funds (ETFs).First launched in the early 1990s,ETFs are securities that combineelements of mutual funds, but do soin a different way. Like mutualfunds, ETFs contain a pool of securi-ties. Like stocks, ETFs are traded onmajor U.S. exchanges and can bebought and sold anytime duringnormal trading hours. For moreinformation on ETFs, visitwww.amex.com.

There are several choices of ETFsthat track industry sectors. For ourstudy we decided to use the SelectSector SPDRs. Launched in early1999, nine sector ETFs are nowtraded on the AMEX. These sectorscan be bought or sold at any timeduring the trading day in the samemanner as buying shares of stock.You can even sell them short. Thenine sector choices are:

• Consumer Staples (XLP)

• Energy (XLE)

• Financial (XLF)

• Health Care (XLV)

• Industrial (XLI)

• Materials (XLB)

• Technology (XLK)

• Utilities (XLU)

The SPDRs are less aggressivethan other sector choices. They arepassively managed and only holdStandard & Poor’s 500 stocks. Theannual management fee is about halfthat of other sector mutual fundchoices and they are liquid. There isgood volume and unlike a stock orclosed-end mutual fund, the numberof shares in the marketplace is notfixed — if the demand for a givenETF outstrips supply at any point, anETF specialist can create new onesfrom a basket of the underlyingsecurities in the fund. When a large

Figure 2. Portfolio Manager screen with a graph of SPDR portfolio back test results (IRR vs.time) displayed in upper window. For comparison, a plot of S&P 500 performance is also shown.

8

AIQ Opening Bell November 2003

March 2002

Table 1. Yearly Returns (%)

Year Sector Trading S&P 500 Index

1999* 8.21 6.392000 -6.44 -10.142001 -15.93 -13.042002 -15.66 -23.372003** 24.79 18.98Average -1.006 -4.236

* beginning on 7/2/99** through 10/15/2003

were being held at that time so noaction was taken.

ResultsWe chose to backtest the SPDRs

because, of the ETF choices, theyhave the most history. The SPDRsbegan trading at the start of 1999.Since the Relative Strength reportrequires six months of data, theearliest our backtest could start wasJuly 1999. That means our test wasrun mostly in a bearish environment.

The yearly results are found inTable 1. While this strategy outper-formed the S&P 500 by about 3% peryear, its performance was not goodenough to recommend it as a tradingsystem. The fact that the sectorscontain only S&P 500 stocks hurt theperformance. Large-cap stocks were

“While this strategy outperformed theS&P 500 by about 3% per year, its

performance was not good enough torecommend it as a trading system.

The fact that the sectors contain onlyS&P 500 stocks hurt the

performance.”

the worst performers during thistime period and the system was

unable to rotateto a sector thatcontained small-cap stocks.Consequently,there were nosectors thatbucked thebearish markettrend.

Figure 2shows a graph of

the SPDR portfolio along with theS&P 500. Although the SPDR

portfolio is above the S&P 500, theirmovement is closely tied together.

I hoped for better results fromthis test but I believe the problemwith this system isn’t the strategybut the vehicles used in the strategy.The SPDR sectors are too closelycorrelated with the S&P 500.

Sometimes knowing whatdoesn’t work is as important asknowing what does work. I expectresults would be improved by usingthe system on the Rydex or Fidelitymutual funds. We’ll reveal theresults of these tests in a future

Stock Splits and other changes:

Stock Ticker Split Approx. Date

ADVO Inc. AD 3:2 11/10/03Landstar System LSTR 2:1 11/14/03Horizon Bancorp HBNC 3:2 11/18/03

Trading Suspended:Apogee Technologies (APGT), Chateau Communities (CPJ),Cobalt Corp. (CBZ), Hispanic Broadcasting (HSP),Legato Systems (LGTO), Quintiles Transnational (QTRN)

Name/Ticker Symbol Changes:AOL Time Warner Inc. (AOL) to Time Warner Inc. (TWX)Cedar Shopping Centers (CEDRD) to Cedar Shopping Centers (CDR)DQE Inc. (DQE) to Duquesne Light Holdings (DQE)Value City Department Stores (RVI) to Retail Ventures (VCD)Wire One Technologies (WONE) to Glowpoint Inc. (GLOW)

STOCK DATA MAINTENANCETradingExpert Pro v7.2

Has New Features &Trading Strategies

For a complete list of all newfeatures in TradingExpert Prov7.2 and to download thisupgrade visit: http://www.aiqsystems.com/TESindex72.htm

Now’s the time to upgrade toAIQ TradingExpert Pro v7.2.Best of all it’s FREE for clients onthe monthly plan with myTrack.New features are concentrated intwo very important areas of thesoftware, Real-Time Alerts andPortfolio Manager. Also avail-able are over 60 new tradingstrategies and indicators.