Constructing a smoothed advance-decline trend filter

A three-layer construction

Editorial framing: TradersWeek reads the archive workflow as a construction sequence with three layers. The first layer records market breadth. The second layer turns that daily count into a smoothed oscillator and a six-month norm. The third layer is a trend filter that withholds a medium-term trend-change hypothesis until a second same-direction outside spike appears after a gap of at least a month.

From the daily count to a smoothed oscillator

The advance-decline line is a running sum of the number of stocks that close higher minus the number that close lower in each session. Market breadth is that daily participation, used as a market-wide signal rather than as a single-index price path.

Net advance-decline figures are taken from the composite tape of listed issues rather than from an exchange's first internal advance-decline print.

A breadth oscillator is formed by applying a 25 percent, seven-day exponential average to daily net advances minus declines. Exponential smoothing here means combining 25 percent of the current net reading with 75 percent of the prior average.

The exponential series may be started on any session. About 40 trading sessions is described as enough for a large move near the start date to stop distorting the reading.

A six-month norm and outside spikes

Six-month clusters of prominent highs and lows on the smoothed series define ordinary reversal bands. Prints well outside those bands are treated as candidate medium-term trend alerts. That typical high and low cluster over a recent half-year that contains no large spikes is the six-month norm.

For an April-through-October 1993 window described as spike-free, the average of ten prominent highs was +229 with tops near +300, and the average of prominent lows was -222 with troughs near -300.

Readings at least 40 percent beyond the prevailing band are treated as more informative than 20 percent or 30 percent overshoots. Spikes clustered inside two to three weeks are counted as one event. An outside spike is a smoothed reading at least 40 percent beyond the current high or low norm.

The confirmation sequence

A medium-term trend-change sequence is specified as an outside spike, a later return to the pre-spike normal range, and a second spike in the same direction separated by at least one month. The trend filter upgrades an oscillator extreme to a medium-term trend-change hypothesis only after that full sequence.

Major trend changes from 1973 through the mid-1990s are described as each showing an outside spike within six months of the matching S&P 500 top or bottom, and most within two months.

When the ordinary range shifts

During a later correction the lower six-month band widened from about -220 to -300 toward about -200 to -500, while the upper extreme stayed near +300 and typical rally tops moved closer to +100.