taking the formula one step beyond
by Ichu Cheng
October 19,1987 witnessed the biggest one-day drop in stock prices in history. The Dow Jones
Industrial Average (DJIA) fell 616 points or 26% in a single day. The drop caught most investors by
surprise. Are there any indicators that could have warned us about the impending crash?
In Figure 1, two parallel lines run along the DJIA line and form a channel which I have developed and
have called the Holt-Winter Channel. A week before the crash, the DJIA price lines crossed the lower
parallel line. This is the sell signal for the Holt-Winter Channel and it provided a timely signal for
The Holt-Winter Channel did not signal the severity of the drop, however, because unlike the
Holt-Winter formula on which it is based, the channel is not intended to forecast future stock prices. The
channel is used as a timing device for getting in and out of a security.
Notice that in November 1986, the channel correctly signaled the major market movement of early 1987.
A month before the crash on October 19,1987, it signaled a weakening in the market. A week before the
crash, it gave a sell signal.