V.6:8 (285-290): Holt-Winter Channel: taking the formula one step beyond by Ichu Cheng

V.6:8 (285-290): Holt-Winter Channel: taking the formula one step beyond by Ichu Cheng
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Holt-Winter Channel: 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 unloading portfolios.

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.

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