April 5, 2011
Combining the scores
Individually, each component score assesses the health of the cyclical trend with respect to a specific characteristic, but only when the component scores are combined do they facilitate the highly reliable identification of cyclical trend inflection points. In order to generate the composite CTS, the component valuation, momentum, sentiment and internal scores are combined via a weighted summation. The following chart displays the resultant CTS during the first 10 years of the secular bear market from 2000.
Every time the CTS moved into buy or sell territory, denoted by the green and red areas on the chart above, a potential cyclical trend inflection point was identified. Most CTS signals result in the generation of a confirmed cyclical trend buy or sell signal, but some do not. For example, the decline into sell territory in 2004 did not produce a sell signal because the cyclical uptrend from 2002 was still so young. Since cyclical uptrends rarely last less than 24 months, any sell signals that occur in young bull markets are considered invalid. In order for a CTS signal to subsequently produce a confirmed inflection point signal, the cyclical trend in progress must be of sufficient duration and it must exhibit follow-through in the opposite direction after the CTS has left signal territory. Of the 43 CTS signals produced since 1940, 28 resulted in the generation of confirmed buy or sell signals.
With respect to overall accuracy, the CTS trading system performed exceptionally well when it was back-tested using historical data from 1940 to 2010, identifying 23 of the 25 cyclical trend inflection points while producing only four incorrect signals – in April 1948, January 1960, October 1969 and November 1981. The following series of graphs displays all 28 signals grouped by decade.
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