Confirming a Change in Price Direction With the Price Direction Indicator (PDI)

Because most buy and sell combinations (trades) make money on the price upside, you want to buy a stock when it is going up in price, not going down. So before you buy a stock, you need to apply a rigorous analysis to the stock's price series to determine with reasonable certainty whether the stock is on a prolonged price upside.

Some upsides are easy to spot just by visually inspecting their price charts. For example, a stock which has gone up for months has a definite up trend. But when an upside stock drops in price, you must decide whether the drop is just a temporary dip or the start of a new downside. Similarly, suppose a downside stock suddenly begins to go up. Is the price increase just temporary or the start of a new upside?

Detecting moves from the upside to the downside and moves from the downside to the upside is the business of technical analysis of price patterns. Being able to consistently spot these price directional changes separates the top money-making traders and investors for the rest of the pack.

The methodology to detect a new price upside or a new price downside that we use at buyupside.com is called the Price Direction Indicator (PDI), a methodology developed by Richard Howard. PDI combines cumulative percent winners (CPW) and cumulative returns (CR), which measure for a price series how many buy and sell combinations make money and how much they make.

As prices rise, the number and percentage of profitable trades increase and their returns increase in value. And as prices fall, these measures decline in value.

PDI, cumulative percent returns and cumulative returns do not exhibit the day-to-day fluctuations which can mask the changes in price direction on conventional charts of closing prices. Therefore, plots of these three measures are very effective at identifying tops and bottoms.

Detecting a Price Move From the Downside to the Upside

To start the PDI analysis for a suspected downside to upside change in price direction, select the price series that you want to analyze. Begin the series with the first price after the last significant peak in prices. This price and its date mark the start of the known downside. End the series with the current price of the suspected upside. Therefore, the price series to be analyzed includes the downside after the known peak, the suspected price bottom and the suspected new upside. If you want, you can plot the series to see its overall price pattern. Normally you use daily closing prices for the PDI analysis but you can use any interval including weekly or monthly closes. Daily closes are used in the following examples.

Next, prepare the selected price series for input to the Price Direction Indicator (PDI) computer program, a free program offered on buyupside.com. The program computes the daily values of PDI, cumulative percent winners and cumulative returns and their 20-day moving averages. For exact formatting details of the price series, see the instructions for downloading and running the PDI program.

Then run the PDI program.

The example below analyzes the downside to upside move for Google (GOOG) for daily prices from February 21, 2006 through April 5, 2006.

First, plot the daily closes and daily PDI values on the same chart to see the relationship between them. Here the PDI values bottomed on March 23, 2006. The daily PDI usually turns up after prices have begun to move up.

Then plot the daily PDI values and their 20-day moving average. The daily PDI crossed its 20-day moving average on March 27.

Then plot the daily cumulative percent winners values with their 20-day moving average. Check to see if daily cumulative percent winners have moved above their 20-day moving average. A move above the 20-day moving average suggests that prices have changed direction to the upside.

In the example, the daily cumulative percent winners crossed their 20-day moving average on March 27.

Next, plot the daily cumulative returns values with their 20-day moving average. Check to see if daily cumulative returns have moved above their 20-day moving average. A move above the 20-day moving average indicates that prices have moved to the upside.

Notice that the daily cumulative returns crossed its 20-day moving average on March 27.

Often cumulative returns values cross their 20-day moving average after the cumulative percent winners have crossed their moving average.

If the daily values of PDI, cumulative percent winners and cumulative returns values are above their respective moving averages, you can be reasonably certain that prices have moved to the upside. Of course, the analysis does not tell you how long the prices will remain of the upside. But in most instances the PDI, CPW and CR values do not change direction in just a few days so they do not react to brief upside and downside blips in prices.

Detecting a Price Move From the Upside to the Downside

To start the PDI analysis for a suspected upside to downside price direction change, select the price series that you want to analyze. Begin the series with the first price after the last significant bottom in prices. This price and date mark the start of the known upside. End the series with the current price of the suspected current downside. Therefore, the price series to be analyzed includes the upside, the suspected peak and the suspected new downside.

Next, prepare the selected price series for input to the Price Direction Indicator (PDI) program and then run the program.

Advanced Micro Devices (AMD), a semiconductor maker, provides the price upside to price downside example. PDI peaked on March 2, 2006 after prices made a broad triple top.

The daily PDI values fell below their 20-day moving average on March 6, 2006.

The cumulative percent winners values fell below their 20-day moving average on February 13, 2006 proving to be a leading indicator of the price downside.

The cumulative returns values fell below their 20-day moving average on March 13, 2006, one month behind the cumulative percent returns. Cumulative returns often lag the cumulative percent winners making the cumulative returns a conservative indicator of a change in price direction.

Related Articles:

Buy and Sell Combinations - An Explanation
Cumulative Percent Winners
Cumulative Returns
Price Direction Indicator (PDI) Detects Changes in Price Direction
Setting and Confirming Buy and Sell Signals for Cyclical Price Patterns

Updated September 10, 2007.