Jeff Kohler the Option Addict | Stock and Options Trading

I had a request to talk about the 4% model. If any of you have read Martin Zweig's book titled "Winning on Wall Street" this model gained it's popularity through this publication.

This method was developed by Ned Davis and it is basically a very simple trend following technique. It is very easy to calculate and analyze. The only complication is having access to the Geometric Value Line Composite Index (symbol $VGY) where you need weekly closing prices to calculate your signals.

The premise is that this method will keep you in the market during upswings and short on the downswings. Here is how it is calculated...

A buy signal is generated when the index rises at least four percent from a previous close. A sell signal is generated when the index falls four percent from a previous close. Remember that to do this you will need to use weekly closing prices to calculate signals, which are very long term signals compared to what we normally deal with here. I will quote a study I located on this model that talks about how accurate or beneficial it would have been to use it...

"From 1961 to 1992, a buy and hold approach on the Value Line Index would have yielded 149 points (3% annual return). Using the Four Percent Model (including shorts) during the same period would have yielded 584 points (13.6% annual return). Interestingly, about half of the signals generated were wrong. However, the average gain was much larger than the average loss--an excellent example of the stock market maxim "cut your losses short and let your profits run."

Again, just another technical indicator out of the hundreds that exist. Hopefully this was useful or was an easy to understand explanation of a new indicator to add to your arsenal. As always I love requests, so feel free to keep sending them.

Posted by Option Addict on 1/05/2007 at 10:09 AM | Permalink