V.10:7 (296-299): The Damping Index by Curtis McKallip Jr.

The Damping Index by Curtis McKallip Jr.

Variety is the spice of life — except when you're trying to optimize a trading system. This new indicator identifies those places on the price graph where highs and lows are getting closer and closer together, and when used in conjunction with buy rules and sell rules, it can be used to create a computerized trading system. Longtime S&C contributor Curtis McKallip demonstrates.

Why is it so difficult to optimize a trading system for different markets? One reason may be that most technical indicators are not easily related to classic economic theory. Designing a trading system becomes not unlike designing an airplane without understanding aerodynamics. You might come up with a design that flies better than another, but not knowing why it does so makes it difficult to translate that success into other designs.

You can relate price patterns to supply and demand curves, even though you may not have all the necessary fundamental data. Those curves are still active; they don't depend on data for their existence. Rather, they are the stuff that markets are made of because they depict human behavior.

When a news event is reported, particularly an unexpected one, the price reacts and then settles down in a zigzag pattern (Figure 1). The price versus quantity chart is known as a cobweb chart because of its appearance. Normally, the equilibrium price of a tradeable occurs at the point where the supply and demand curves cross. When a reported news event forces the price up without shifting either curve, that causes the market to supply more of the product than it needs (or less if the price is forced lower). Since the demand is not sufficient to account for all these products, the price drops below equilibrium, which in turn causes producers to cut back on production, producing less than necessary. When the supply drops, the price goes back up.