Published 4/20/95
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Introducing the MIDAS Method of Technical Analysis
by Paul Levine[Image]
In this, the first of a series of columns, we will introduce to the
community of technical analysts a new approach to charting the price history
of a stock or commodity. I call this technique the MIDAS method, an acronym
for Market Interpretation/Data Analysis System. It is designed to focus
attention on the dynamic interplay of support/resistance and
accumulation/distribution which are the ultimate determinants of price
behavior. Indeed, a Midas chart makes immediately visually apparent an
unexpected degree of orderliness in what might otherwise seem to be a random
or chaotic process.
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Take a look at the first of the figures. Here we have a standard price and
volume bar chart for Magma Copper as of the April 19, 1995 close. I do not
believe any of the familiar charting methods would contribute anything of
value to the interpretation of this chart. There are no clearly evident
trend channels, trendlines, support or resistance lines, etc. Indeed, after
the initial runup from 9 to 17, the subsequent sideways pattern appears to
be random and trendless.
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Now look at the Midas chart for the same stock. First observe that to
simplify things we only plot the daily average price (i.e. the average of
the high and low). More signifcantly, we plot the prices vs. CUMULATIVE
VOLUME rather than time. This has the effect of giving less visual weight to
periods of relative inactivity (e.g. Feb 1995) since the lower cumulative
volume increase during such a period compresses the daily points into a
smaller space. (We will see later on why it is important to deemphasize
periods when there is little alteration of the ownership profile of the
people holding the stock).
Next, observe the curve marked "theoretical support level", and in
particular how this corresponds precisely to the trend reversal points. You
might think that in some sense the theoretical support curve has been
"fitted" to these reversal points, much in the same way that trendlines are
fitted to bar or point and figure charts. Remarkably, this is not the case;
the theoretical support curve is determined a priori, has no adjustable
parameters and follows from a very simple equation. In a later column I will
derive this equation from a quantitative consideration of a few universal
features in the psychology of the trader. For now just take my word for the
fact that the theoretical support curve was constructed in a universal
fashion from the raw price and volume data.
From the standpoint of practical trading, the important thing is that the
price trend reversals (eight in all) all occurred precisely where they were
expected to. This by itself both confirms a primary bull trend, and provides
low risk entry points for long positions. One simply waits for the price to
approach the support curve and jumps on board at the first indication of a
"bounce". (Where to sell is of course another matter which we will treat at
length in future columns).
But how strong a bounce are we to expect, or to put it another way, how
strong is the underlying bull trend? To assess this, we add one final
feature to the Midas chart, viz. a minor variant of Joe Granville's on-
balance volume ("obv"). This curve is constructed by adding today's volume
to the (accumulated) on-balance volume if today's average price exceeds
yesterday's average price, subtracting it if it is less, and not changing
the on-balance volume if there has been no day to day change in average
price. (The absolute scale of the obv curve is immaterial and is simply
adjusted to fit on the same chart as the price). The value of obv is that it
makes immediately clear whether a stock is undergoing accumulation or
distribution.
In the present example we see that obv is in a definite upward trend
(accumulation) and that the obv trend continues even during periods of
sideways price action. This is ideal bullish confirmation of the price
trend.
To summarize the ground we've covered in this first brief introduction, we
have shown how price and volume data for a specific stock can be displayed
in a new fashion which makes immediately apparent an underlying trend that
is all but hidden in a conventional chart of the same data. It is a totally
remarkable circumstance that this general approach to charting appears to be
of practical value in most markets for which I have been able to test it
against price and volume data. In my next column I'll give a few more
examples of Midas charts for stocks of current interest. When we have
examined together several such examples and have thereby developed a
familiarity with this new way of looking at things, there should be
sufficient motivation to delve more deeply into the mechanics of generating
the theoretical support curve. In so doing, we will come to discover other
unexpected regularities in what has often been dismissed as random walk
processes. Stay tuned!
This is the first article in a series. Click here to go to the next article.
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Paul Levine first became interested in technical analysis when he was a
"runner" on Wall Street as a high school student. After graduating from MIT
and gaining a PhD in theoretical physics from CalTech, he took a fresh look
at the problem some thirty years ago and stumbled upon what has now evolved
into the Midas method. Following retirement as Chief Scientist and a
co-founder of Megatek Corporation in 1981, he developed further elaborations
of the method and is now in his fourth year as a professional trader. He can
be reached at: midas@thegroup.net.
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Copyright © 1995 by Paul Levine. All rights reserved.
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