The 4% Indicator Revisited by Michael J. Collins061
This simple time-tested indicator allows investors to trade with the trend to achieve above-average returns.
As trend-following traders, we understand that success depends on identifying and trading with the price trend of the markets. We have come to appreciate the saying that “the trend is your friend.” More than 20 years ago, Martin Zweig, in his book Winning On Wall Street, featured a simple indicator designed to help an investor follow the price trend of the markets. Zweig called this the 4% indicator. In his book he illustrated that for the 22-year period ended late 1988, if an investor followed this indicator, a modest $10,000 investment would have grown to more than $233,000! This is an approximate 15% compounded annual rate of return — a remarkable return that significantly exceeded market returns.
But that was then. Due to changing market dynamics, many indicators appear to work for a certain time and as conditions change, the indicator loses its effectiveness despite what backtesting results have shown.
This article revisits the 4% model and explores its effectiveness in current market conditions. Is this indicator still relevant 20 years later? To find out, I developed a trading model.
THE 4% INDICATOR
Often, the simpler the indicator, the easier the model is to execute. It doesn’t get much simpler! As Zweig shows in his book, the 4% indicator uses the Value Line Composite Index to generate the buy and sell signals. The Value Line Composite is a collection of 1,700 companies that are equally weighted and covered in the Value Line Investment Survey, a popular investment service. This index consists primarily of mid-cap stocks and is therefore more representative of underlying market movements.