Magic T Theory

The T Theory is a method of analysis in the stock market. It was developed by former U.S. Marine Corps Terrence H. Laundry, and is highly endorsed by famous trader Martin S. Schwartz. The basic premise of the theory is that, if the market just spent six months going sideways before hitting a low, then the theory predicts that it will go up from there for 6 months. Therefore, if you can measure the time of the previous correction, you will have a good idea when the current trend will end.

There are two ways to measure the length of a correction: one for the longer term and another for the shorter term. The longer-term measurement is done with the McClelland Summation Index. For those who have never heard of it before, the index is an oscillator measuring the number of advancing securities minus declining ones listed in a certain stock exchanges. Therefore, a high reading indicates optimism and a low one indicates pessimism.

To measure the length of correction with the McClelland Summation Index, simply count from the last higher high of the index to the latest lower low. Extending this period from the low will be the projected end of the consequent uptrend. Here is some examples from 2012 to 2016.

As you can see, the McClelland Summation Index is fairly reliable in finding cycles in the market. However, it is not sensitive enough for the shorter cycle. Therefore, Laundry prefers to use another indicator for cycles which last only a few weeks. This indicator is on-balance volume (OBV). Developed by Joseph Granville in the 1960s, it compares bullish volume to bearish one as a way to gauge the sentiment of the market. Below is an example using OBV in the T Theory in late 2012.

In conclusion, the stock market does move in cycles. By knowing the current point of the cycle, one can increase his chance of trading success. The T theory is certainly the simplest and easiest way to discover the underlying cycles in the market.

REFERENCE: Laundry, T. H. (1997). A 1997 Introduction to T Theory. Retrieved on 10 Oct 2016: http://cdn3.traderslaboratory.com/forums/attachments/34/31965d1350013176-beyond-taylor-a1997introttheory_.pdf