1 Aroon_ 3
2 AVERAGE TRUE RANGE_ 5
2.1 Overview_ 5
2.2 Interpretation_ 5
2.3 Calculation_ 5
3 Bollinger Bands 6
3.1 Overview_ 6
3.2 Interpretation_ 6
4 Chande Momentum Oscillator 7
5 Commodity Channel Index_ 9
5.1 Overview_ 9
5.2 Interpretation_ 9
6 De-trended Price Oscillator 10
7 Directional system (ADX) 10
7.1 DEFINITION_ 10
7.2 INTERPRETATION_ 10
8 DIRECTIONAL MOVEMENT_ 11
8.1 Overview_ 11
8.2 Interpretation_ 11
9 Elliot Oscillator 12
10 Ichimoku Kinko Huo_ 13
10.1 Interpretation_ 13
11 Moving Average Convergence/Divergence 16
11.1 Overview_ 16
11.2 Interpretation_ 16
11.3 Crossovers 16
11.4 Overbought/Oversold Conditions 16
11.5 Divergences 16
12 McClellan Oscillator 18
13 MOMENTUM_ 19
13.1 Overview_ 19
13.2 Interpretation_ 19
14 Moving Average 20
14.1 Overview_ 20
14.2 Interpretation_ 20
15 Parabolic SAR_ 22
15.1 Overview_ 22
15.2 Interpretation_ 22
16 Price Rate-Of-Change 23
16.1 Overview_ 23
16.2 Interpretation_ 23
17 Relative Strength Index_ 24
17.1 Overview_ 24
17.2 Interpretation_ 24
18 Stochastic Oscillator 25
18.1 Overview_ 25
18.2 Interpretation_ 25
19 Support and Resistance 26
20 Ultimate Oscillator 27
21 VOLATILITY, CHAIKIN'S_ 28
21.1 Overview_ 28
21.2 Interpretation_ 28
21.3 Calculation_ 28
22 Williams' %R_ 29
22.1 Interpretation_ 29
Developed by Tushar Chande in 1995, Aroon is an indicator system that can be used to determine whether a stock is trending or not and how strong the trend is. "Aroon" means "Dawn's Early Light" in Sanskrit and Chande choose that name for this indicator since it is designed to reveal the beginning of a new trend.
The Aroon indicator system consists of two lines, Aroon(up) and Aroon(down). It takes a single parameter which is the number of time periods to use in the calculation. Aroon(up) is the amount of time (on a percentage basis) that has elapsed between the start of the time period and the point at which the highest price during that time period occurred. If the stock is setting a new low for the given time period, Aroon(up) will be zero. On the other hand, if the stock closes higher than it has during the rest of the time period, Aroon(up) will be +100. For each subsequent period that passes without another new high, Aroon(up) moves down by an amount equal to (1 / # of periods) x 100.
Technically, the formula for Aroon(up) is:
[ [ (# of periods) - (# of periods since highest high during that time) ] / (# of periods) ] x 100
For example, consider plotting a 10-period Aroon(up) line on a daily chart. If the highest price for the past ten days occurred 6 days ago (4 days since the start of the time period), Aroon(up) for today would be equal to ((10-6)/10) x 100 = 40. If the lowest price in that same period happened yesterday (i.e. on day 9), Aroon(down) for today would be 90.
Aroon(down) is calculated in just the opposite manner, looking for new lows instead of new highs. When a new low is set, Aroon(down) is equal to +100. If the stock is setting a new high for the given time period, Aroon(down) will be zero. And so on...
The formula for Aroon(down) is :
[ [ (# of periods) - (# of periods since lowest low during that time) ] / (# of periods) ] x 100
A separate indicator called the Aroon Oscillator can be constructed by subtracting Aroon(down) from Aroon(up). Since Aroon(up) and Aroon(down) oscillate between 0 and +100, the Aroon Oscillator oscillate between -100 and +100 with zero as the center crossover line.
Interpretation Guidelines: Chande states that when Aroon(up) and Aroon(down) are moving lower in close proximity, it signals that a consolidation phase is under way and no strong trend is evident. When Aroon(up) dips below 50, it indicates that the current trend has lost its upwards momentum. Similarly, when Aroon(down) dips below 50, the current downtrend has lost its momentum. Values above 70 indicate a strong trend in the same direction as the Aroon (up or down) is under way. Values below 30 indicate that a strong trend in the opposite direction is underway.
The Aroon Oscillator signals an upward trend is underway when it is above zero and a downward trend is underway when it falls below zero. The farther away the oscillator is from the zero line, the stronger the trend.
In some ways, Aroon is similar to Wilder's DMI system (and the Aroon Oscillator is similar to Wilder's ADX line) however the Aroon is constructed in a completely different manner. Divergences between the two systems may be very instructive.
2 AVERAGE TRUE RANGE
The Average True Range ("ATR") is a measure of volatility. It was introduced by Welles Wilder in his book, New Concepts in Technical Trading Systems, and has since been used as a component of many indicators and trading systems.
Wilder has found that high ATR values often occur at market bottoms following a "panic" sell-off. Low Average True Range values are often found during extended sideways periods, such as those found at tops and after consolidation periods.
The Average True Range can be interpreted using the same techniques that are used with the other volatility indicators. Refer to the discussion on Standard Deviation for additional information on volatility interpretation.
The True Range indicator is the greatest of the following:
The distance from today's high to today's low.
The distance from yesterday's close to today's high.
The distance from yesterday's close to today's low.
The Average True Range is a moving average (typically 14-days) of the True Ranges.
3 Bollinger Bands
Bollinger Bands are similar to moving average envelopes. The difference between Bollinger Bands and envelopes is envelopes are plotted at a fixed percentage above and below a moving average, whereas Bollinger Bands are plotted at standard deviation levels above and below a moving average. Since standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods. Bollinger Bands were created by John Bollinger.
Bollinger Bands are usually displayed on top of security prices, but they can be displayed on an indicator. These comments refer to bands displayed on prices. As with moving average envelopes, the basic interpretation of Bollinger Bands is that prices tend to stay within the upper- and lower-band. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (i.e., low volatility), the bands narrow to contain prices.
Mr. Bollinger notes the following characteristics of Bollinger Bands.
Sharp price changes tend to occur after the bands tighten, as volatility lessens.
When prices move outside the bands, a continuation of the current trend is implied.
Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend.
A move that originates at one band tends to go all the way to the other band. This observation is useful when projecting price targets.
4 Chande Momentum Oscillator
The Chande Momentum Oscillator (CMO) was developed by Tushar Chande. A scientist, an inventor, and a respected trading system developer, Mr. Chande developed the CMO to capture what he calls “pure momentum.” For more definitive information on the CMO and other indicators we highly recommend the book The New Technical Trader by Tushar Chande and Stanley Kroll. The CMO is closely related to, yet unique from, other momentum oriented indicators such as RSI, Stochastic, Rate-of-Change, etc. It is most closely related to Welles Wilder’s RSI (see Relative Strength Index), yet it differs in several ways:
It uses data for both up days and down days in thenumerator, thereby directly measuring momentum.
The calculations are applied on unsmoothed data. Therefore, short-term extreme movements in price are not hidden. Once calculated, smoothing can be applied to the CMO, if desired.
The scale is bounded between +100 and -100, therebyallowing youto clearly see changes in net momentum using the 0 level.
The bounded scale also allows you to conveniently compare values across different securities.
You may find the expert named "Equis - Chande Momentum Oscillator" helpful in interpreting the Chande Momentum Oscillator.See Attaching an Expert to a Chart for more information an experts.
The CMO can be used to measure several conditions.
Overbought/oversold. The primary method of interpreting the CMO islooking for extreme overbought and oversold conditions. As a general rule, Mr. Chande quantifies an overbought level at +50 and theoversold level at -50. At +50, up-day momentum is three times the down-day momentum. Likewise, at -50, down-day momentum is three times the up-day momentum. These levels correspond to the 70/30 levels on the RSI indicator.
You could also establish overbought/oversold entry and exit rules by plotting a moving average trigger line on the CMO. For example, if you are using the default 20-period CMO, a 9-period moving average may serve as a good trigger line. Buy when the CMO crosses above the 9-period trigger line; sell when it crosses below.
Trendiness. The CMO (much like the VHF indicator, see Vertical Horizontal Filter) can also be used to measure the degree to which a securities trending. The higher the CMO, the stronger the trend.
Low values of the CMO show a security in a sideways trading range.
You may find the CMO helpful in establishing the entry and exit rules ofa trend following syste.
Enter when the CMO is high and exit when it moves lower.
Divergence. Although not specifically mentioned in Mr. Chande’s book, you could also look for divergence between the CMO and the price, as is often done with other momentum indicators.
See the discussion about divergence in the Interpretation section of RSI(see Relative Strength Index).
Other. Although not specifically mentioned in Mr. Chande’s book, you may also look for chart formations
(head and shoulders, rising wedges, etc.), failure swings, and support/resistance.
5 Commodity Channel Index
The Commodity Channel Index (CCI) measures the variation of a security's price from its statistical mean. High values show that prices are unusually high compared to average prices whereas low values indicate that prices are unusually low. Contrary to its name, the CCI can be used effectively on any type of security, not just commodities. The CCI was developed by Donald Lambert.
There are two basic methods of interpreting the CCI: looking for divergences and as an overbought/oversold indicator.
A divergence occurs when the security's prices are making new highs while the CCI is failing to surpass its previous highs. This classic divergence is usually followed by a correction in the security's price.
The CCI typically oscillates between ±100. To use the CCI as an overbought/oversold indicator, readings above +100 imply an overbought condition (and a pending price correction) while readings below -100 imply an oversold condition (and a pending rally).
6 De-trended Price Oscillator
The De-trended Price Oscillator (DPO) is an indicator that attempts to eliminate the trend in prices.
De-trended prices allow you to more easily identify cycles and overbought/oversold levels.
7 Directional system (ADX)
Directional system was developed by J. Wilder in the middle of 1970s as an addition to the system PARABOLIC SAR, and then it was advanced by a number of the analysts. ADX defines the tendency and shows, whether it moves quickly enough to follow it. ADX helps to take benefit, being still in the middle of important trends.
This indicator promotes searching of tendency force. If ADX raises, it means that the market tendency becomes stronger. At such times, it is desirable to conclude the bargains only in the direction of the tendency. When ADX falls, it means that the tendency is questionable. Signals submitted by oscillators (RSI, Momentum) are important in this case.
The meaning of the directional analysis is in the fact that it traces changes in mass optimism and pessimism, measuring ability of the bulls and bears to remove the prices beyond the limits of a price range of the previous day. If the today's best price is above yesterday's one, the market becomes more optimistic. And on the contrary, if the today's lowest price is below the yesterday's lowest one, it is possible to speak about changing of the market to pessimism.
8 DIRECTIONAL MOVEMENT
The Directional Movement System helps determine if a security is "trending." It was developed by Welles Wilder and is explained in his book, New Concepts in Technical Trading Systems.
The basic Directional Movement trading system involves comparing the 14-day +DI ("Directional Indicator") and the 14-day -DI. This can be done by plotting the two indicators on top of each other or by subtracting the +DI from the -DI. Wilder suggests buying when the +DI rises above the -DI and selling when the +DI falls below the -DI.
Wilder qualifies these simple trading rules with the "extreme point rule." This rule is designed to prevent whipsaws and reduce the number of trades. The extreme point rule requires that on the day that the +DI and -DI cross, you note the "extreme point." When the +DI rises above the -DI, the extreme price is the high price on the day the lines cross. When the +DI falls below the -DI, the extreme price is the low price on the day the lines cross.
The extreme point is then used as a trigger point at which you should implement the trade. For example, after receiving a buy signal (the +DI rose above the -DI), you should then wait until the security's price rises above the extreme point (the high price on the day that the +DI and -DI lines crossed) before buying. If the price fails to rise above the extreme point, you should continue to hold your short position. In Wilder's book, he notes that this system works best on securities that have a high Commodity Selection Index. He says, "as a rule of thumb, the system will be profitable on commodities that have a CSI value above 25. When the CSI drops below 20, then do not use a trend-following system."
9 Elliot Oscillator
The difference between 5period ma & 35period ma plotted as a HISTOGRAM.
In wave 3 the prices are tading in a very srong trend, and beacause of this the 5ma moves away from the slower 35ma at a fast rate & causes the oscillator to have a high peak in ~3.
In ~5 prices are higher, but lacks the srong trend as in ~3 & therefore a smaller peak in the oscillator.
Historical tests have shown that 94% of time the 5/35 oscilator will pull back to zero during ~4 & therefore identifies ~4.
10 Ichimoku Kinko Huo
The Ichimoku Kinko Hyo Japanese charting technique, developed before World War II, aimed at portraying, in a snapshot, where the price was heading and when was the right time to enter or exit the market. This was all performed without the aid of any other technical analysis technique (or study).
The word Ichimoku can be translated to mean 'a glance' or 'one look'. Kinko translates into 'equilibrium' or 'balance', with respect to price and time, and Hyo is the Japanese word for 'chart'. Thus, Ichimoku Kinko Hyo simply means 'a glance at an equilibrium chart', providing a panoramic view of where prices are likely to go and the position one should undertake.
Invented by a Japanese newspaper writer with a pen name of 'Ichimoku Sanjin', meaning 'a glance of a mountain man', Ichimoku charts have become a popular trading tool in Japan, not only within the equity market, but in the currency, bond, futures, commodity, and options markets as well. The technique was published over 30 years ago but has only gained international attention only within the last few years.
The Ichimoku chart consists of five lines and the calculation of these five lines involves only taking the midpoints of previous highs and lows, similar to the Moving Average studies. Even with its simplicity, the completed chart is able to present a clear perspective into the price action of the security at hand.
The five lines are calculated as follows:
1) Tenkan-Sen = Conversion Line = (Highest High + Lowest Low) / 2, for the past 9 periods
2) Kijun-Sen = Base Line = (Highest High + Lowest Low) / 2, for the past 26 periods
3) Chikou Span = Lagging Span = Today's closing price plotted 26 periods behind
4) Senkou Span A = Leading Span A = (Tenkan-Sen + Kijun-Sen) / 2, plotted 26 periods ahead
5) Senkou Span B = Leading Span B = (Highest High + Lowest Low) / 2, for the past 52 periods, plotted 26 periods ahead
Kumo = Cloud = area between Senkou Span A and B
An example of an Ichimoku chart is illustrated above.
As can be seen from the formulas, Ichimoku is very similar to the Moving Average studies. And like moving averages, buy and sell signals are given with the crossover technique.
A bullish signal is issued when the Tenkan-Sen (green line) crosses the Kijun-Sen (purple line) from below. On the other hand, a bearish signal is issued when the Tenkan-Sen crosses the Kijun-Sen from above.
Moreover, there are, in fact, different levels of strength for the buy and sell signals of an Ichimoku chart.
First, if there was a bullish crossover signal and the crossover occurred above the Kumo (or clouds), this would be considered a very strong buy signal (indicated with three green up arrows). In contrast, if there was a bearish crossover signal and the crossover occurred below the Kumo, this would be considered a very strong sell signal (indicated with three red down arrows, as above).
Secondly, a normal buy or sell signal would be issued if the crossover took place within the Kumo (or clouds). These signals would be indicated with two green up arrows, for a buy signal, and two red down arrows, for a sell signal.
Thirdly, a weak buy signal would be issued if there was a bullish crossover that occurred below the Kumo (or clouds). This is indicated with only one green up arrow (as above). On the other hand, a weak sell signal would be issued if there was a bearish crossover that occurred above the Kumo. This is indicated with only one red down arrow.
Another striking feature of the Ichimoku charting technique is the identification of support and resistance levels. These levels can be predicted by the presence of Kumo (or clouds). The Kumo can also be used to help identify the prevailing trend of the market. If the price is above the Kumo, the prevailing trend is said to be up. And if the price is below the Kumo, the prevailing trend is said to be down.
A final feature of the Ichimoku chart is the Chikou Span (or Lagging Span). This line can be used to determine the strength of the buy or sell signal. If the Chikou Span is below the closing price for 26 periods ago and a sell signal is issued, then the strength is with sellers, otherwise it is a weak sell signal. Conversely, if there was a buy signal and the Chikou Span is above the price for 26 periods ago, then there is strength to the upside, otherwise, it can be considered a weak buy signal. This feature can also be incorporated into the other signals.
There are three key time periods - 9, 26, and 52. When these indicators were created back in the 1930s, a trading week was 6 days long.
9 periods or days = one and half week
26 periods = one month
52 periods = two months
Now that the trading week is 5 days, one may want to modify the parameters to the following:
7 or 8 periods or days = one and half week
22 periods = one month
44 periods = two months
The Visual Trading sets the Ichimoku Kinko Hyo to the default parameters of 9, 26, and 52 periods.
11 Moving Average Convergence/Divergence
(M A C D)
The MACD (Moving Average Convergence/Divergence) is a trend following momentum indicator that shows the relationship between two moving averages of prices. The MACD was developed by Gerald Appel, publisher of Systems and Forecasts.
The MACD is the difference between a 26-day and 12-day exponential moving average. A 9-day exponential moving average, called the "signal" (or "trigger") line is plotted on top of the MACD to show buy/sell opportunities. (Appel specifies exponential moving averages as percentages. Thus, he refers to these three moving averages as 7.5%, 15%, and 20% respectively.)
The MACD proves most effective in wide-swinging trading markets. There are three popular ways to use the MACD: crossovers, overbought/oversold conditions, and divergences.
The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the MACD rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.
The MACD is also useful as an overbought/oversold indicator. When the shorter moving average pulls away dramatically from the longer moving average (i.e., the MACD rises), it is likely that the security price is overextending and will soon return to more realistic levels. MACD overbought and oversold conditions exist vary from security to security.
A indication that an end to the current trend may be near occurs when the MACD diverges from the security. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. A bullish divergence occurs when the MACD is making new highs while prices fail to reach new highs. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.
12 McClellan Oscillator
The McClellan Oscillator, developed by Sherman and Marian McClellan, is a market breadth indicator that is based on the smoothed difference between the number of advancing and declining issues on the New York Stock Exchange. The McClellan Oscillator is one of the most popular breadth indicators. Buy signals are typically generated when the McClellan Oscillator falls into the oversold area of -70 to -100 and turns up. Sell signals are generated when the oscillator rises into the overbought area of +70 to +100 and then turns down.
Extensive coverage of the McClellan Oscillator is provided in their book Patterns for Profit.
The Momentum indicator measures the amount that a security's price has changed over a given time span.
The interpretation of the Momentum indicator is identical to the interpretation of the Price ROC. Both indicators display the rate-of-change of a security's price. However, the Price ROC indicator displays the rate-of-change as a percentage whereas the Momentum indicator displays the rate-of-change as a ratio.
There are basically two ways to use the Momentum indicator:
You can use the Momentum indicator as a trend-following oscillator similar to the MACD (this is the method I prefer). Buy when the indicator bottoms and turns up and sell when the indicator peaks and turns down. You may want to plot a short-term (e.g., 9-period) moving average of the indicator to determine when it is bottoming or peaking.
If the Momentum indicator reaches extremely high or low values (relative to its historical values), you should assume a continuation of the current trend. For example, if the Momentum indicator reaches extremely high values and then turns down, you should assume prices will probably go still higher. In either case, only trade after prices confirm the signal generated by the indicator (e.g., if prices peak and turn down, wait for prices to begin to fall before selling).
You can also use the Momentum indicator as a leading indicator. This method assumes that market tops are typically identified by a rapid price increase (when everyone expects prices to go higher) and that market bottoms typically end with rapid price declines (when everyone wants to get out). This is often the case, but it is also a broad generalization.
As a market peaks, the Momentum indicator will climb sharply and then fall off-- diverging from the continued upward or sideways movement of the price. Similarly, at a market bottom, Momentum will drop sharply and then begin to climb well ahead of prices. Both of these situations result in divergences between the indicator and prices
14 Moving Average
A Moving Average is an indicator that shows the average value of a security's price over a period of time. When calculating a moving average, a mathematical analysis of the security's average value over a predetermined time period is made. As the security's price changes, its average price moves up or down.
There are five popular types of moving averages: simple (also referred to as arithmetic), exponential, triangular, variable, and weighted. Moving averages can be calculated on any data series including a security's open, high, low, close, volume, or another indicator. A moving average of another moving average is also common.
The only significant difference between the various types of moving averages is the weight assigned to the most recent data. Simple moving averages apply equal weight to the prices. Exponential and weighted averages apply more weight to recent prices. Triangular averages apply more weight to prices in the middle of the time period. And variable moving averages change the weighting based on the volatility of prices.
The most popular method of interpreting a moving average is to compare the relationship between a moving average of the security's price with the security's price itself. A buy signal is generated when the security's price rises above its moving average and a sell signal is generated when the security's price falls below its moving average. The following chart shows the Dow Jones Industrial Average ("DJIA") from 1970 through 1993.
Also displayed is a 15-month simple moving average. "Buy" arrows were drawn when the DJIA's close rose above its moving average; "sell" arrows were drawn when it closed below its moving average.
This type of moving average trading system is not intended to get you in at the exact bottom nor out at the exact top. Rather, it is designed to keep you in line with the security's price trend by buying shortly after the security's price bottoms and selling shortly after it tops.
The critical element in a moving average is the number of time periods used in calculating the average. When using hindsight, you can always find a moving average that would have been profitable (using a computer, I found that the optimum number of months in the preceding chart would have been 43). The key is to find a moving average that will be consistently profitable. The most popular moving average is the 39-week (or 200-day) moving average. This moving average has an excellent track record in timing the major (long-term) market cycles.
Moving averages can also be calculated and plotted on indicators. The i nterpretation of an indicator's moving average is similar to the interpretation of a security's moving average: when the indicator rises above its moving average, it signifies a continued upward movement by the indicator; when the indicator falls below its moving average, it signifies a continued downward movement by the indicator.
Indicators which are especially well-suited for use with moving average penetration systems include the MACD, Price ROC, Momentum, and Stochastics.
Some indicators, such as short-term Stochastics, fluctuate so erratically that it is difficult to tell what their trend really is. By erasing the indicator and then plotting a moving average of the indicator, you can see the general trend of the indicator rather than its day-to-day fluctuations.
Whipsaws can be reduced, at the expense of slightly later signals, by plotting a short-term moving average (e.g., 2-10 day) of oscillating indicators such as the 12-day ROC, Stochas-tics, or the RSI. For example, rather than selling when the Stochastic Oscillator falls below 80, you might sell only when a 5-period moving average of the Stochastic Oscillator falls below 80.
15 Parabolic SAR
The Parabolic Time/Price System, developed by Welles Wilder, is used to set trailing price stops and is usually referred to as the "SAR" (stop-and-reversal). This indicator is explained thoroughly in Wilder's book, New Concepts in Technical Trading Systems.
The Parabolic SAR provides excellent exit points. You should close long positions when the price falls below the SAR and close short positions when the price rises above the SAR.
If you are long (i.e., the price is above the SAR), the SAR will move up every day, regardless of the direction the price is moving. The amount the SAR moves up depends on the amount that prices move.
16 Price Rate-Of-Change
The Price Rate-of-Change (ROC) indicator displays the difference between the current price and the price x-time periods ago. The difference can be displayed in either points or as a percentage. The Momentum indicator displays the same information, but expresses it as a ratio.
It is a well recognized phenomenon that security prices surge ahead and retract in a cyclical wave-like motion. This cyclical action is the result of the changing expectations as bulls and bears struggle to control prices.
The ROC displays the wave-like motion in an oscillator format by measuring the amount that prices have changed over a given time period. As prices increase, the ROC rises; as prices fall, the ROC falls. The greater the change in prices, the greater the change in the ROC.
The time period used to calculate the ROC may range from 1-day (which results in a volatile chart showing the daily price change) to 200-days (or longer). The most popular time periods are the 12- and 25-day ROC for short to intermediate-term trading. These time periods were popularized by Gerald Appel and Fred Hitschler in their book, Stock Market Trading Systems.
The 12-day ROC is an excellent short- to intermediate-term overbought/oversold indicator. The higher the ROC, the more overbought the security; the lower the ROC, the more likely a rally. However, as with all overbought/over-sold indicators, it is prudent to wait for the market to begin to correct (i.e., turn up or down) before placing your trade. A market that appears overbought may remain overbought for some time. In fact, extremely overbought/oversold readings usually imply a continuation of the current trend.
The 12-day ROC tends to be very cyclical, oscillating back and forth in a fairly regular cycle. Often, price changes can be anticipated by studying the previous cycles of the ROC and relating the previous cycles to the current market
17 Relative Strength Index
The Relative Strength Index (RSI) is a popular oscillator. It was first introduced by Welles Wilder in an article in Commodities (now known as Futures) Magazine in June, 1978. Step-by-step instructions on calculating and interpreting the RSI are also provided in Mr. Wilder's book, New Concepts in Technical Trading Systems.
The name "Relative Strength Index" is slightly misleading as the RSI does not compare the relative strength of two securities, but rather the internal strength of a single security. A more appropriate name might be "Internal Strength Index." Relative strength charts that compare two market indices, which are often referred to as Comparative Relative Strength.
When Wilder introduced the RSI, he recommended using a 14-day RSI. Since then, the 9-day and 25-day RSIs have also gained popularity. Because you can vary the number of time periods in the RSI calculation, I suggest that you experiment to find the period that works best for you. (The fewer days used to calculate the RSI, the more volatile the indicator.)
The RSI is a price-following oscillator that ranges between 0 and 100. A popular method of analyzing the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the RSI then turns down and falls below its most recent trough, it is said to have completed a "failure swing." The failure swing is considered a confirmation of the impending reversal.
In Mr. Wilder's book, he discusses five uses of the RSI in analyzing commodity charts. These methods can be applied to other security types as well.
Tops and Bottoms. The RSI usually tops above 70 and bottoms below 30. It usually forms these tops and bottoms before the underlying price chart.
Chart Formations. The RSI often forms chart patterns such as head and shoulders (page 215) or triangles (page 216) that may or may not be visible on the price chart.
Failure Swings (also known as support or resistance penetrations or breakouts). This is where the RSI surpasses a previous high (peak) or falls below a recent low (trough).
Support and Resistance. The RSI shows, sometimes more clearly than price themselves, levels of support and resistance.
Divergences. As discussed above, divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the RSI. Prices usually correct and move in the direction of the RSI.
18 Stochastic Oscillator
Stochastic (sto kas'tik) adj. 2. Math. Designating a process having an infinite progression of jointly distributed random variables. Webster's New World Dictionary
The Stochastic Oscillator compares where a security's price closed relative to its price range over a given time period.
The Stochastic Oscillator is displayed as two lines. The main line is called "%K." The second line, called "%D," is a moving average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line.
?There are several ways to interpret a Stochastic Oscillator. Three popular methods include:
Buy when the Oscillator (either %K or %D) falls below a specific level (e.g., 20) and then rises above that level. Sell when the Oscillator rises above a specific level (e.g., 80) and then falls below that level.
Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.
Look for divergences. For example, where prices are making a series of new highs and the Stochastic Oscillator is failing to surpass its previous highs.
19 Support and Resistance
Think of security prices as the result of a head-to-head battle between a bull (the buyer) and a bear (the seller). The bulls push prices higher and the bears push prices lower. The direction prices actually move reveals who is winning the battle.
Support levels indicate the price where the majority of investors believe that prices will move higher, and resistance levels indicate the price at which a majority of investors feel prices will move lower.
To use this formula most effectively, use the parameters dialogue to change the style to a dotted line while increasing the line weighting.
20 Ultimate Oscillator
"The trouble for most oscillator workers was, and has continued to be,that while frequently oscillatorslead sometimes they lead far too early and, instead of buying a bottom,you are buying falling daggersand getting sliced up. Even the best oscillators consistently givepremature buy and sell signals.I believe my "Ultimate Oscillator" corrects this", stated by Larry Williams, in the Apr 85 issue of Technical Analysis of Stocks & Commodities.
21 VOLATILITY, CHAIKIN'S
Chaikin's Volatility indicator compares the spread between a security's high and low prices. It quantifies volatility as a widening of the range between the high and the low price.
There are two ways to interpret this measure of volatility. One method assumes that market tops are generally accompanied by increased volatility (as investors get nervous and indecisive) and that the latter stages of a market bottom are generally accompanied by decreased volatility (as investors get bored).
Another method (Mr. Chaikin's) assumes that an increase in the Volatility indicator over a relatively short time period indicates that a bottom is near (e.g., a panic sell-off) and that a decrease in volatility over a longer time period indicates an approaching top (e.g., a mature bull market).
As with almost all experienced investors, Mr. Chaikin recommends that you do not rely on any one indicator. He suggests using a moving average penetration or trading band system to confirm this (or any) indicator.
Chaikin's Volatility is calculated by first calculating an exponential moving average of the difference between the daily high and low prices. Chaikin recommends a 10-day moving average.
Next, calculate the percent that this moving average has changed over a specified time period. Chaikin again recommends 10 days.
22 Williams' %R
(pronounced "percent R") is a momentum indicator that measures overbought/oversold levels. Williams' %R was developed by Larry Williams.
The interpretation of Williams' %R is very similar to that of the Stochastic Oscillator except that %R is plotted upside-down and the Stochastic Oscillator has internal smoothing.
To display the Williams' %R indicator on an upside-down scale, it is usually plotted using negative values (e.g., -20%). For the purpose of analysis and discussion, simply ignore the negative symbols.
Readings in the range of 80 to 100% indicate that the security is oversold while readings in the 0 to 20% range suggest that it is overbought.
As with all overbought/oversold indicators, it is best to wait for the security's price to change direction before placing your trades. For example, if an overbought/oversold indicator (such as the Stochastic Oscillator or Williams' %R) is showing an overbought condition, it is wise to wait for the security's price to turn down before selling the security. (The MACD is a good indicator to monitor change in a security's price.) It is not unusual for overbought/oversold indicators to remain in an overbought/oversold condition for a long time period as the security's price continues to climb/fall. Selling simply because the security appears overbought may take you out of the security long before its price shows signs of deterioration.
An interesting phenomena of the %R indicator is its uncanny ability to anticipate a reversal in the underlying security's price. The indicator almost always forms a peak and turns down a few days before the security's price peaks and turns down. Likewise, %R usually creates a trough and turns up a few days before the security's price turns up.