4 minute read
Technical indicators that make sense - remembering J Welles Wilder
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Gerry Celaya, MSTA
Gerry Celaya has been professionally involved in global market research and investments since 1986. Gerry is a director at Redtower Asset Management and Tricio Investment Advisors, providing research and risk management consultancy services in the FX and investment markets to professional clients around the world... Read more
J. Welles Wilder passed away on 18 April 2021, leaving a legacy of changing the way that many analysts, traders and investors study and trade financial markets.
I never met him, but I reached out to my first boss at Money Market Services, Cindy Armijo (née Keel) and she remembered him with fondness. Cindy recalled seeing him at MTA and TSAA meetings when he was passing through the San Francisco Bay area. He was one of her early mentors, and was a traditionalist in the sense that "read the charts" was his foundational philosophy, but he brought so much more to the table.
His seminal book ‘New Concepts in Technical Trading Systems’ was published in 1978. It is not a long read - only 118 pages. However, it is also not an easy read as Welles Wilder illustrates how to calculate his indicators in great detail using tables and worksheets, which can be tedious at times.
There were books on technical and chart analysis written before 1978 and plenty of books about technical and chart analysis have been written since of course, including a plethora on ‘behavioural finance’ over the last 20 years as authors cast a wide net to make sales. But Welles Wilder’s book stands out as he comes right out and says:
“I need a system to trade the markets, I need a system to tell me if I am trading a trending or non-trending market, and I need a money management system”.
His book details the different indicators and systems that should be used when markets are trending or not trending (and how to determine the different states of trend). Analysts, traders and investors may often use the technical indicators and systems that he invented, without even knowing it. As the reader goes through the book, one of the final chapters details his ‘Commodity Selection Index’. Here the author gets into leverage cost and volatility, and ties in some of his other indicators in order to attempt to focus the trader on the markets that it makes sense to trade at that time.
As he states:
“Most technical systems are trend-following systems; however, most commodities are in a good trending mode (high directional movement) only about 30% of the time. If the trader follows the same commodities or stocks all of the time, then his system has to be good enough to make more money 30% of the time than it will give back 70% of the time.”
The most famous of his indicators introduced in this book is the Relative Strength Index (RSI), which every Bloomberg and Reuters terminal chart uses, along with all of the free (and paid) internet charting /broking systems. Having programmed Welles Wilder’s indicators into mainframe computers in the 1980s, moving onto Lotus 123 (remember that?) and then Excel spreadsheets, writing analysis, proprietary trading at banks and helping to run funds and investments in all asset
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classes, I have learned that it takes discipline to use his indicators and systems. For example, the RSI seems simple, but this is not just an ‘overbought/oversold’ indicator. There are a lot of nuances (which Welles Wilder goes through) in using the RSI that are important to understand when you are using it. Figure 1-4 below show various indicators that Welles Wilder created, underlining how much we owe to his creative and quantitative efforts.
Figure 1: Welles Wilder RSI (TradingView)
Figure 3: Welles Wilder Volatility (TradingView) Figure 2: Welles Wilder Parabolic SAR (TradingView)
Figure 4: Welles Wilder DMI (TradingView)
Table 1: The more you lose, the harder it is to make it back
Initial capital lost 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% Required gains to recover 5.3% 11.1% 17.6% 25.0% 33.3% 42.9% 53.8% 66.7% 81.8% 100% 122% 150% 186% 233% 300% 400% 567% 900% A table that appears near the end of the book in the ‘Capital Management’ chapter is important for any analyst, trader and investor to understand (my version is Table 1).
There is a cost to losing money, and the more of your capital that you lose, the bigger the hill to climb to make it back. A 20% loss of your initial capital requires a 33.33% return to make up, for example, while a 90% loss of your initial capital requires a 900% return to make it up.
A simple lesson, and common sense, but often forgotten it seems. Thank you, Welles Wilder.
