Introducing The Special K Scan
Rationale for the Special K
At my Chartcon presentation, I outlined the characteristics and uses of my Special K indicator and introduced a new advanced scan for identifying trading signals. I’ll talk about that, as well as how you can set up such scans later, but first a rationale for this unusual indicator.
The Special K is a momentum indicator that combines short-term, intermediate and long-term velocity into one complete series. It has two functions, first to identify primary trend reversals at a relatively early stage, and second to use that information for timing short-term pro-trend price moves. Figure 1 shows all three trends as they might be expressed in an overlaid momentum format:
Figure 1
Figure 2 features just the (green) primary trend and the (orange) Special K (SPK) , which is really the short-term trend shown in the previous chart.
Figure 2
In an ideal world, the SPK ought to peak and trough more or less simultaneously with the price at bull and bear market turning points. In most situations, that actually happens. I estimate about 70-75% of the time. When it does, the trick is to identify these turning points as quickly as possible after they have taken place. The formula assumes that prices are revolving around the four-year business cycle. As a result, when a linear uptrend such as the extended 2002-2007 bull market in equities develops, the SPK leads turning points in the way any momentum indicator might diverge negatively with the price it is monitoring. Alternatively, when the cycle is truncated, as was the case for the 1987 crash, the indicator lags the price. While the prime function of the SPK is to identify primary trend turning points, it is also helpful in assessing trading opportunities. That’s because this indicator also includes short-term data in its calculation. That means it can not only identify near-term trends for trading purposes, but it is also able to put that information in context with the direction and maturity of the primary trend. Let's consider both those aspects starting with primary trend identification.
Calculation
The SPK is the sum of several different weighted averages of different rate-of-change calculations. The periods and weightings were selected based on daily simulations of the short, intermediate and long-term KST’s.
Special K = 10 Period Simple Moving Average of ROC(10) * 1
+ 10 Period Simple Moving Average of ROC(15) * 2
+ 10 Period Simple Moving Average of ROC(20) * 3
+ 15 Period Simple Moving Average of ROC(30) * 4
+ 50 Period Simple Moving Average of ROC(40) * 1
+ 65 Period Simple Moving Average of ROC(65) * 2
+ 75 Period Simple Moving Average of ROC(75) * 3
+100 Period Simple Moving Average of ROC(100)* 4
+130 Period Simple Moving Average of ROC(195)* 1
+130 Period Simple Moving Average of ROC(265)* 2
+130 Period Simple Moving Average of ROC(390)* 3
+195 Period Simple Moving Average of ROC(530)* 4
Note that at least 725 data points are required to accurately calculate the SPK. If less data is available, then the final line of the calculation is skipped. To really appreciate the long term perspective offered by this indicator 5-10 years or more of additional data are required. That way it's possible to see if the security in question is experiencing the expected cyclical swings. Most do, but occasionally you will find some that do not.
How to Use the Special K to Identify Long-term Price Movements
It is easy to spot SPK turning points with the benefit of hindsight. A good example is shown in Chart 1 featuring the CRB Composite, where most of the SPK turning points line up with those for the price.
Chart 1
Unfortunately, traders and investors work in real time. This means that we need to come up with some techniques that help identify such turning points at a relatively early stage. There are three principal techniques that have proved useful.
- Since the SPK is quite a jagged indicator, it lends itself best to trendline construction as shown in Charts 1 and 2. For example, if a trendline of 9-months or more is violated, this usually means that the primary trend for the SPK has reversed. When the indicator changes trend, the price usually does too. To make quite sure, we need to make sure that price itself is confirming that of the SPK. The price confirms with a trendline break or any other trend reversal technique, such as a MA crossover, price pattern completion, etc.
- It is normal to run a moving average through the Special K. The default is a 100-day smoothed by a 100-day SMA. Crossovers of the average by the SPK itself signal a reversal in the direction of the primary trend. Occasionally, as with all moving average situations, whipsaws are triggered. When combined with a trendline break though, a stronger and more reliable signal is triggered. An example at the 2003 bottom for US equities is shown in Chart 2, where the MA crosses and trendline violations develop more or less simultaneously.
- Occasionally the SPK traces out price patterns. When they are confirmed by some kind of trend reversal in the price itself, this usually represents a valid indication of a reversal in the prevailing primary trend. Chart 3, featuring the Gold Trust ETF (GLD) offers three examples.
Chart 2
Chart 3
How to identify pro-trend short-term buy and sell signals
One of the most important principles for short-term traders to grasp is the fact that trades executed in the direction of the main trend are much more likely to be successful than those generated in a counter-cyclical way. If you are going to experience a whipsaw or false breakout, chances are that this will be taking place in the opposite direction of the main trend. Knowing the direction of that dominant trend gives you a definite edge, and that’s where the SPK comes in. That’s because it can offer you an objective technique for determining the direction of the primary trend. The solution we adopt is to determine the position of the SPK relative to its signal line, which is that 100-day MA smoothed by another 100-day SMA. Positive readings i.e. above the signal line indicate a primary bull market environment and vice versa.
If the direction of the primary trend is bullish, trades for the long side would be initiated when the SPK triggers a short-term signal. This could happen when the SPK itself changes direction or crosses a moving average etc. The best approach I have found, is to wait for the SPK to cross above its 10-day MA, as shown in Chart 4. I am certainly not saying that this is the best approach, I am sure it’s possible to could come up with something just as good, or even better. It’s also possible to combine the primary trend SPK bull/bear signal with a different indicator. Such examples could include an RSI crossing back above the oversold 30 level, or the MACD crossing above its signal line, etc. All are possible, but the main thing to understand is that buy signals can only be triggered if the SPK itself is above its signal line (below it for sell signals). These are shown with orange, upward arrows in the chart below. Using the SPK positive 10-day MA crossover approach, trades would be closed out when the SPK re-crosses back below its 10-day MA. Short sales would be initiated in the opposite way i.e. when the SPK is below its long-term MA and crosses below its 10-day MA. The chart below shows such a system for the Market Vectors Gold Miners ETF, the GDX. The red vertical line represents the start of a bear market phase as defined by the Special K/Signal line relationship and the green one a bull market. Note that the bull market begins in November of 2008, yet is not signaled until 3-months later in February. Two good opportunities were lost, but this exercise is all about choosing the moment when the odds are in your favor, not shooting at every rabbit that moves. Opportunities will definitely be missed, but with so many markets and securities around the world it doesn’t matter. By-and-large the pro trend bull and bear signals in Chart 4 work out. However, the sell signal at 1 and the buy signal at 2 do not. They have one thing in common and that was that the KST in the bottom panel was oversold at the time of the bear signal and moderately overbought at the time of the bullish one. It just underscores the point that these signals are merely filters that alert you to the possibility that a buying or selling opportunity. Further research is required though, before taking action.
Note that no buy signals are generated during the bearish periods, only sell signals (brown, downward arrows). The “Example Sell Point” was sub-par because it developed during a bull market. Unfortunately, at the time, the system was still in a bearish mode because the SPK was below its signal line. As with all technical indicators, rather than blindly using this approach as a mechanical system, it's better to use pro trend signals as an alert and then use other indicators as a filter in a “weight of the evidence” approach. Incidentally, you can save this chart arrangement by clicking on it, displaying a non-annotated chart and saving the result as a new chart style.
Chart 4
Using the scan engine to troll for short-term SPK buy signals
With the inclusion of the Special K into the StockCharts scan engine, it is now possible to search a list of securities meeting the short-term buy in a long-term bull condition.
The following represent formulas for searching through your favorite lists of stocks or other entities. It’s important to remember that each calculation involves a substantial amount of data crunching. For this reason my recommendation is to limit your scanning list to a thousand items, otherwise, the system may crash. In these examples, I have limited my selection to 600-stocks included in the NASDAQ 100 and the S&P 500. Since there is some double counting because some issues are included in both indexes I have used the expression “or” instead of the more counter-intuitive “and” in line one.
To set up the scan yourself, go to the Members tab and select the advanced scan workbench. In the Scan Criteria box remove the default syntax [type = stock] AND [Daily SMA(20,Daily Volume) > 40000] and replace it by cutting and pasting one of the following formulas. Don’t forget to save each one permanently with the “save as" command. Repeat the process for any of the formulas you wish to use.
Sample syntax for Special K scans
Special K Bullish Short-term Position
[[group is NASDAQ100] or [group is SP500]]
and [Special K > Special KSignal(100,100)]
and [Special K > SMA(10,Special K)]
Special K Bullish Short-term Cross
[[group is NASDAQ100] or [group is SP500]]
and [Special K > Special KSignal(100,100)]
and [Special K x SMA(10,Special K)]
Special K Bearish Short-term Position
[[group is NASDAQ100] or [group is SP500]]
and [Special K < Special KSignal(100,100)]
and [Special K < SMA(10,Special K)]
Special K Bearish Short-term Cross
[[group is NASDAQ100] or [group is SP500]]
and [Special K < Special KSignal(100,100)]
and [SMA(10,Special K) x Special K]
The Special K Short-term Bullish Position returns securities where the SPK is above both the signal line and its 10-day MA.
The Special K Bullish Short-term Cross returns securities that have triggered a signal using the latest intraday data. Because it’s just looking for the crossover this scan will return far fewer results than the previous one.
The Special K Short-term Bearish Position returns securities where the SPK is below the signal line and its 10-day MA.
The Special K Bearish Short-term Cross returns securities that have triggered a signal using the latest intraday data. Because it’s just looking for the crossover this scan will return far fewer results than the previous one.
It’s most important to remember that this technique can be very useful, but is best incorporated as a filter in an overall approach. In other words, do not treat these alerts as gospel, use them as a starting point for further technical investigation prior to taking action.
Good luck and good charting,
Martin J. Pring
The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.
