Zweig's Four Percent Solution

01/14/02 01:14:58 PM

by David Penn

Marty Zweig's 4% buy rule netted QQQ traders nearly 30% in two months. How has the sell signal fared since then?

Security: QQQ
Position: N/A

One of my favorite market timing strategies comes from the Marty Zweig's Winning on Wall Street. While there is a wealth of valuable information in his classic book on long-term market timing and investing, one often overlooked gem is his Four Percent Model Indicator. This model is special both because of its simplicity and its winning record over time. Zweig used the Four Percent Model Indicator on the ValueLine index from 1966 to 1985 and showed how the Indicator dramatically outperformed a buy and hold strategy over the same period of time (16.4% long and short versus 2% buy and hold.)

I've conducted further research in the Four Percent Model Indicator, using the Nasdaq, S&P 500, Dow 30, and Nasdaq 100. (see "Autumn of Infamy: The Ebbing of Buy and Hold," November 5, 2001, Working Money). While there was significant outperformance in all of the averages except the S&P 500, the results in the Nasdaq 100 were the most dramatic. Zweig himself anticipated this, pointing to how the Four Percent Model Indicator is most effective in a volatile market with strong trends. It should be added that most trend-following approaches will outperform in such markets. The particular value of Zweig's Four Percent Model Indicator is that the data collection (the weekly close), and data processing (sell 4% weekly down closes, buy 4% weekly up closes), are all very easy to do.

So far, Zweig's Four Percent Model Indicator looks to have caught most of the war rally.

Graphic provided by: MetaStock.

Both the QQQ and the DIA have been worthwhile vehicles for the Four Percent Model Indicator over the past two years. The S&P 500 and SPY have outperformed, but the margin of outperformance is more impressive in the DIA, which also serve as a confirmation of any signals from the QQQ. Looking at the QQQ, there was a buy signal on October 8th at 31.13. This bullishness was part of the war rally in the wake of the September 11th terrorist attack and the Model would have had traders and investors long for the move 10 days and four points from the bottom of 28.2.

The Model's buy signal and long position were intact until mid-December, when days of weakness produced a sell signal on December 14th at 40.11, after a 28.8% advance. The Four Percent Model Indicator is a long/short indicator, geared toward keeping the trader or investor in the market at all times. The indicator can, however, be amended so that an investor may go to cash or a bond position when the indicator suggests a short position. In any event, the sell signal arrived just as the upward trendline of the rally was broken on the downside.

This short position has seen some significant volatility over the 30 days since it was issued. Four days after the sell signal, the QQQ looked to be breaking down from a trading range, only to successfully test the low end of the trading range at the beginning of January. The QQQ rallied toward the top end of the trading range during the first half of the month, but weakness again returned to the Nasdaq 100, as prices look to be stuck in the middle of the range between 40.5 and 42.

While the short position in the QQQ called for by the Four Percent Model Indicator has yet to become profitable, much less an outperforming trade, there is reason for hope for QQQ bears. Most importantly, the run from 31.13 to 40.11 took place as part of a countertrend, bear market rally. Thus, adopting a short position at this time is tantamount to betting on a resumption of the long-term, bear market swing the Nasdaq 100 entered back in September 2000, a bear market swing that at 16 months is certainly more than middle-aged, but probably not quite ready for the retirement home. Additional support for the bearish case can be found in the failed rally in the second half of December. This rally failed to take out the previous high of 43.5 made on December 6th. All the same, it will probably take a failed test of support at 38.5, a breaking down from the trading range, to finally put the bulls back on the run.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Comments

Date:�01/15/02Rank:�5Comment:�Terriffic!!!

Date:�01/15/02Rank:�4Comment:�As usual, Mr Penn presents a resonable expectation of the unseen.

Date:�01/15/02Rank:�4Comment:�

Date:�01/15/02Rank:�4Comment:�Quote: Looking at the QQQ, there was a buy signal on October 8th 31.13 ---- the model would have traders ---long ---10 days and four points from the bottom of 28.2. Looking at the chart right now, (hind sight), anybody can make such a successful claim. Please explain how you would have come to the conclusion on or before exacly October 8th without the benefit of chart actions thereafter. e.wachuku@gte.net

Date:�01/15/02Rank:�5Comment:�

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Zweig's Four Percent Solution

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