Constructing extendedness from a 10 percent swing filter

Keep direction, the swing-pivot, and extent

A trend-filter is a percentage threshold that ignores smaller oscillations and only marks a new swing when price has moved far enough from the last high or low. A percentage swing filter declares a new trend only after price moves at least the chosen threshold from the last swing high or low.

The construction must keep three pieces of state: the current direction, the swing-pivot, and the current extent. The swing-pivot is the last high or low that the filter is currently using as the reference for the open trend.

Those same objects support a momentum-strategy. The procedure stays with the prevailing swing until a measured reversal threshold is met, then treats the new direction as the working trend.

Why a flip misses the first part of the swing

Waiting for the filter to flip direction guarantees missing the first portion of each new swing equal to the threshold. A smaller threshold reduces that lag and raises the chance of being shaken out in sideways action.

Editorial reading: once that lag is accepted as a property of the filter, the next construction step is not a faster flip. It is a rule that still uses the open swing-pivot after the threshold has already been paid.

Treat extendedness as state, not as a flip

Extendedness is the percentage distance of the latest close above the last swing low in an upswing, or below the last swing high in a downswing. In this construction it is the measured percentage beyond the last filtered high or low, and it is used as a state variable rather than as a mechanical buy-or-sell flip.

A rule-based-entry is a testable entry, exit, or size rule that depends on how far the current swing has traveled from the last filtered pivot. Editorial note: extendedness is the recorded distance that makes that rule testable, because it is measured from the swing-pivot still in force.

How the 10 percent monthly case was stored

The same construction was applied to monthly S&P 500 closes from 1950 through 1995. The 10 percent threshold was stored as a separate parameter, and the first five years were excluded from later calculations.

One tabulated reading of that state said that once the market was more than 75 percent extended from its last 10 percent correction, a negative 12-month return was expected and a decline was assigned a 60 percent probability. Editorial note: that reading is a historical statement about a stored state. It is not a present-day forecast and it is not a buy or sell instruction.

Use extendedness to scale commitment

A related position-sizing rule concentrated leverage only while the market was between zero and 25 percent extended. The construction treats extendedness as a risk-weighting input to be combined with other indicators, including reducing exposure as the swing lengthens and noting a later pocket of profitability between 75 percent and 100 percent extended.

The finished indicator does not date the next reversal. It only assigns a probability that the current filtered trend continues or reverses.