In the past month, Mark Hulbert, proprietor of the highly regarded Hulbert Financial Digest, has written several times about the fact that many market pundits are following an indicator known as "The Coppock Guide." This little known yet highly regarded market timing indicator is considered by some to be extremely useful, while others are not so sure. But of course - and as usual - most of the people looking at this indicator simply follow the crowd and don't look at it in its most useful light.

The Coppock Guide

The Coppock Guide attempts to identify major buying opportunities in the stock market based on a shift in momentum. The indicator is only updated once a month using the monthly closing low for the Dow Jones Industrials Average.

Here are the month-end calculations:

A=Calculate the percentage gained or lost by the Dow over the past 11 months.

B=Calculate the percentage gained or lost by the Dow over the past 14 months.

C=Calculate the average of these two readings

D=Calculate a 10-month front-weighted moving average of C*

* Multiply this month's average *10, last months * 9, the month before that by 8, etc. Then add together all of the values and divide by 55.

The resulting value for D is this month's Coppock Guide value.

The Standard Interpretation

The way most followers of the Coppock Guide interpret this indicator is to look for a drop into negative territory, followed by a one-month reversal to the upside. This is considered to be a "buy" signal. And in fact there is some utility to this method, but not nearly as much as proponents of this index suggest. Figure 1 displays the Coppock Guide fluctuations since 1900 through today.

Chart 1 - The Coppock Guide (1900-2009)
click here for larger view

This indicator reversed to the upside at the end of May 2009, thus theoretically triggering a new buy signal. Does this have any real meaning? Well, let's take a look. One common method of interpretation is to look for an upside reversal from a negative level and then buy the Dow and hold until the Coppock Guide closes lower for one month. Assuming one earned the nominal rate of 1% of interest while out of the stock market, the results based on this method - versus that of a buy-and-hold approach - appear in Chart 2.

Chart 2 - Standard Coppock Guide Reversal Method (blue line) versus Buy-and-Hold (red line)

As you can see in Chart 2, there is some good news and some bad news regarding this method. The good news is that the systematic approach outperformed a buy-and-hold approach for about 97 years with much less volatility. The bad news is that this method vastly underperformed during the great bull market of the 1990s, and as of today is essentially even with a buy-and-hold approach. So both proponents and critics of the Coppock Guide have some ammunition with which to make their case.

It's The Trend, Stupid

So in the end most followers of the Coppock Guide tingle with anticipation when the indicator drops into negative territory, excitedly looking for a new buy signal when the index finally ticks higher, all the while hoping that the next signal will be more like the ones that occurred in 1982, 1984 and 1988 (Dow up 35%, 28%, and 27% respectively, twelve months later), rather than those that occurred in 1931, 1941, and January of 2002 (Dow down -57%, -18% and -19% twelve months later. And all the while they will likely miss something that is right under their collective noses. It's all about the trend.

To put is as succinctly as possible:

• Up is good
• Down is bad

No surprise there.

But how do we define up and down? Here goes:

• The trend is UP if the Coppock Guide closes this month above its level of 3 months ago.
• The trend is DOWN if the Coppock Guide closes this month below its level of 3 months ago.

How good is up? And how bad is down? Chart 3 displays the growth of $1,000 starting in 1902 through today using this method (and assuming that 1% of interest is earned annually while out of the stock market) versus a buy-and-hold approach.

Chart 3 - Coppock Trend System versus Buy-and-Hold (1902-2009)

For the record:

• $1,000 invested at the starting point of this test in 1902 using a buy-and-hold approach would be worth $179,000 today.
• $1,000 invested using my Coppock Trend System would be worth $415,000 today.
• My Coppock Trend System was only in the stock market about 50% of the time.

Also, for the record, while the popular interpretation of the Coppock Guide issued a buy signal at the end of May (by virtue of reversing to the upside while in negative territory), my Coppock Trend System is still at least another month away from flashing a new buy signal. This would only occur if the Dow closes June 2009 at 8573.90 or higher.

So to paraphrase a popular - if not politically correct - phrase:

Patience, uh, people, patience.

Jay Kaeppel
Staff Writer and Author of "Seasonal Stock Market Trends"
Optionetics.com ~ Your Options Education Site

Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

NOTES:

I will be teaching a session on Seasonal-based trading at this year's Optionetics OASIS, June 18-21. I look forward to seeing many of you there. For more information about this incredible event, please click here.

To learn more about Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, please click here.

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