Joint strength and sentiment rules for entries and exits

What the procedure checks

The case-study procedure does not issue a long or a short from a single chart condition. It reads price together with two strength lines, then applies a contrarian sentiment filter before a signal is allowed.

A rising relative-strength line means the stock is outperforming the market. A rising absolute-strength line means the stock is behaving better than usual given its beta and current market action. Beta measures how sensitive a stock is to the market's direction.

The short-interest ratio is a sentiment gauge of how much short exposure is at risk if price advances. The contrarian sentiment filter requires strengthening price while skeptics remain numerous, or weakening price while bulls remain numerous, before a signal is allowed.

The long rule in the first case

The case-study long rule requires strengthening price behavior at the same time that many participants remain skeptical.

In the first equity case, a mid-1989 price peak coincided with flat relative strength and declining absolute strength. Editorial note: that peak is not a joint long, because the strength lines did not confirm the price high.

Near the end of 1990 in that first case, price and relative strength made new lows while absolute strength turned up and the short-interest ratio stayed relatively high, which the procedure treated as a complete long setup.

The short rule in the second case

The matching short-side rule requires weakening price behavior at the same time that many participants remain bullish.

In the second equity case, an early-1989 price peak showed flat relative strength and declining absolute strength, after which short interest kept shrinking as price fell.

Approaching November 1990 in the second case, absolute strength broke out first, then relative strength broke out, and price advanced against growing short interest. That confirmation order is a sequential breakout: absolute strength improves first, relative strength follows, and price then advances.

Later in that second case, absolute strength diverged negatively at a price high, relative strength then broke down as shorts covered, and an extended decline followed. That price high against a downturn in the strength line is a negative divergence.

When one condition is not enough

Editorial note: the teaching point is not that every breakout or every divergence is a trade. A sequential breakout without the contrarian sentiment filter, a negative divergence without agreement from the other lines, or a sentiment imbalance without confirming strength is an incomplete reading.

If beta-adjusted strength, relative strength, and the crowd's lean do not arrive together, the third outcome of the same test is to stand aside.