Bse Charting - Indicators Help
Moving Averages - Simple and Exponential
Bollinger Bands
Chande Vidya
Directional Mov.Index - ADX
Keltner Channel
MACD
Money Flow Index (MFI)
Moving Average Envelope
On Balance Volume (OBV)
Price Median
Price ROC - Rate of Change%
Relative Strength Index (RSI)
Stochastics Oscillator
Williams PctR
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Moving
Averages - Simple and Exponential |
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Introduction
Moving averages smooth the
price data to form a trend following indicator. They do not predict price
direction, but rather define the current direction with a lag. Moving averages
lag because they are based on past prices. Despite this lag, moving averages
help smooth price action and filter out the noise. They also form the building
blocks for many other technical indicators and overlays, such as Bollinger
Bands, MACD etc.
The two most popular types of
moving averages are the Simple Moving Average (SMA) and the Exponential Moving
Average (EMA). These moving averages can be used to identify the direction of
the trend or define potential support and resistance levels.
Simple Moving Average
A simple moving average is
formed by computing the average price of a security over a specific number of
periods. 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.
Exponential Moving Average
Exponential moving averages
reduce the lag by applying more weight to recent prices. The weighting applied
to the most recent price depends on the number of periods in the moving average.
Simple vs Exponential
Moving Averages
Even though there are clear
differences between simple moving averages and exponential moving averages, one
is not necessarily better than the other. Exponential moving averages have less
lag and are therefore more sensitive to recent prices - and recent price
changes. Exponential moving averages will turn before simple moving averages.
Simple moving averages, on the other hand, represent a true average of prices
for the entire time period. One could also interpret that simple moving averages
may be better suited to identify support or resistance levels. Chartists should
experiment with both types of moving averages as well as different timeframes to
find the best fit.
Moving Average Periods and
Timeframes
The length of the moving
average depends on the analytical objectives. Short moving averages (5-20
periods) are best suited for short-term trends and trading. Chartists interested
in medium-term trends would opt for longer moving averages that might extend
20-60 periods. Long-term investors will prefer moving averages with 100 or more
periods.
Some moving average lengths
are more popular than others. The 200-day moving average is perhaps the most
popular. Because of its length, this is clearly a long-term moving average.
Next, the 50-day moving average is quite popular for the medium-term trend. Many
chartists use the 50-day and 200-day moving averages together.
Trend Identification
The same signals can be
generated using simple or exponential moving averages. The direction of the
moving average conveys important information about prices. A rising moving
average shows that prices are generally increasing. A falling moving average
indicates that prices, on average, are falling. A rising long-term moving
average reflects a long-term uptrend. A falling long-term moving average
reflects a long-term downtrend.
Moving Average Crossover
Signals
Moving averages can be used to
generate signals with simple price crossovers. A bullish signal is generated
when prices move above the moving average. A bearish signal is generated when
prices move below the moving average.
Two moving averages can be
used together to generate crossover signals. Double crossovers involve one
relatively short moving average and one relatively long moving average. As with
all moving averages, the general length of the moving average defines the
timeframe for the system. A system using a 5-day EMA and 35-day EMA would be
deemed short-term. A system using a 50-day SMA and 200-day SMA would be deemed
medium-term, perhaps even long-term. Moving average crossovers produce
relatively late signals. After all, the system employs two lagging indicators.
The longer the moving average periods, the greater the lag in the signals. These
signals work great when a good trend takes hold. However, a moving average
crossover system will produce lots of whipsaws in the absence of a strong trend.
There is also a triple
crossover method that involves three moving averages. Again, a signal is
generated when the shortest moving average crosses the two longer moving
averages. A simple triple crossover system might involve 5-day, 10-day and
20-day moving average
Support and Resistance
Moving averages can also act
as support in an uptrend and resistance in a downtrend. A short-term uptrend
might find support near lets say a 20-day simple moving average.
Moving Average Conclusions
The advantages of using moving
averages need to be weighed against the disadvantages. Moving averages are trend
following, or lagging, indicators that will always be a step behind. This is not
necessarily a bad thing though. After all, the trend is your friend and it is
best to trade in the direction of the trend.
Introduction
Developed by John Bollinger,
Bollinger Bands are volatility bands placed above and below a moving average.
Volatility is based on the standard deviation, which changes as volatility
increases and decreases. The bands automatically widen when volatility increases
and narrow when volatility decreases.
Bollinger Bands consist of a
middle band with two outer bands. The middle band is a simple moving average
that is usually set at 20 periods. A simple moving average is used because the
standard deviation formula also uses a simple moving average. The look-back
period for the standard deviation is the same as for the simple moving average.
The outer bands are usually set 2 standard deviations above and below the middle
band.
The following characteristics
are indicated by the Bollinger Bands.
a.Sharp price changes tend to
occur after the bands tighten, as volatility lessens.
b. When prices move outside
the bands, a continuation of the current trend is implied.
c. Bottoms and tops made
outside the bands followed by bottoms and tops made inside the bands indicates
reversals in the trend.
d.A move that originates at
one band generally tends to go all the way to the other band. This observation
is useful when projecting price targets.
Conclusions
Bollinger Bands reflect
direction with the 20-period SMA and volatility with the upper/lower bands. As
such, they can be used to determine if prices are relatively high or low.
According to Bollinger, the bands should contain 88-89% of price action, which
makes a move outside the bands significant. Technically, prices are relatively
high when above the upper band and relatively low when below the lower band.
However, relatively high should not be regarded as bearish or as a sell signal.
Likewise, relatively low should not be considered bullish or as a buy signal.
Prices are high or low for a reason. As with other indicators, Bollinger Bands
are not meant to be used as a stand alone tool. Chartists should combine
Bollinger Bands with basic trend analysis and other indicators for confirmation.
Introduction
VIDYA is the short form of
Variable Index DYanamic Average. It was developed by Tushar Chande and first
presented in 1992 in his article in the journal Technical Analysis of Stocks and
Commodities.
VIDYA looks like a moving
average. It is a combination of Adaptive Moving Average and Exponential Moving
Average. It gives weight to recent data based on volatility of the data series,
more the volatility more the weight to recent data.
VIDYA effectively compensates
for trading (frequent price fluctuations in a short period) and trending (a
consistent direction of price over a longer period) times. During trading times
short-term averages give many false signals, while long-term averages give late
signals in trending times. With the smoothing constant as well as volatility
index in its formula VIDYA adjusts its sensitivity in trading as well as
trending time
Interpretation & Conclusion
The interpretation is similar
to other averages, VIDYA is also used for confirming trends and overall price
direction. The price line moving above the VIDYA indicates an uptrend suitable
for Buy trades The price line moving below the VIDYA indicates an downtrend
suitable for Sell trades.
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Directional
Movment Index - ADX |
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Introduction
The Directional Movement Index
(also called ADX), Minus Directional Indicator (-DI) and Plus Directional
Indicator (+DI) represent a group of directional movement indicators that form a
trading system developed by Welles Wilder. Wilder designed ADX with commodities
and daily prices in mind, but these indicators can also be applied to stocks.
The Average Directional Index (ADX) measures trend strength without regard to
trend direction. The other two indicators, Plus Directional Indicator (+DI) and
Minus Directional Indicator (-DI), complement ADX by defining trend direction.
Used together, chartists can determine both the direction and strength of the
trend.
Interpretation
The Average Directional Index
(ADX) is used to measure the strength or weakness of a trend, not the actual
direction. Directional movement is defined by +DI and -DI. In general, the bulls
have the edge when +DI is greater than - DI, while the bears have the edge when
- DI is greater. Crosses of these directional indicators can be combined with
ADX for a complete trading system.
At its most basic the Average
Directional Index (ADX) can be used to determine if a security is trending or
not. This determination helps traders choose between a trend following system or
a non-trend following system. Wilder suggests that a strong trend is present
when ADX is above 25 and no trend is present when below 20. There appears to be
a gray zone between 20 and 25. Chartists may need to adjust the settings to
increase sensitivity and signals. ADX also has a fair amount of lag because of
all the smoothing techniques. Many technical analysts use 20 as the key level
for ADX.
Conclusions
The directional movement
indicator calculations are complex, interpretation is straight-forward and
successful implementation takes practice. +DI and - DI crossovers are quite
frequent and chartists need to filter these signals with complementary analysis.
Setting an ADX requirement will reduce signals, but this uber-smoothed indicator
tends to filter as many good signals as bad. In other words, chartists might
consider moving ADX to the back burner and focusing on the Directional
Indicators to generate signals. These crossover signals will be similar to those
generated using momentum oscillators. Therefore, chartists need to look
elsewhere for confirmation help. Volume-based indicators, basic trend analysis
and chart patterns can help distinguish strong crossover signals from weak
crossover signals. For example, chartists can focus on +DI buy signals when the
bigger trend is up and - DI sell signals when the bigger trend is down.
Introduction
Keltner Channels are
volatility-based envelopes set above and below an exponential moving average.
This indicator is similar to Bollinger Bands, which use the standard deviation
to set the bands. Instead of using the standard deviation, Keltner Channels use
the Average True Range (ATR) to set channel distance. The channels are typically
set two Average True Range values above and below the 20-day EMA. The
exponential moving average dictates direction and the Average True Range sets
channel width. Keltner Channels are a trend following indicator used to identify
reversals with channel breakouts and channel direction. Channels can also be
used to identify overbought and oversold levels when the trend is flat.
Interpretation
Indicators based on channels,
bands and envelopes are designed to encompass most price action. Therefore,
moves above or below the channel lines warrant attention because they are
relatively rare. Trends often start with strong moves in one direction or
another. A surge above the upper channel line shows extraordinary strength,
while a plunge below the lower channel line shows extraordinary weakness. Such
strong moves can signal the end of one trend and the beginning of another.
Keltner Channels are a trend following indicator. As with moving averages and
trend following indicators, Keltner Channels lag price action. The direction of
the moving average dictates the direction of the channel. In general, a
downtrend is present when the channel moves lower, while an uptrend exists when
the channel moves higher. The trend is flat when the channel moves sideways.
A channel upturn and break
above the upper trendline can signal the start of an uptrend. A channel downturn
and break below the lower trendline can signal the start a downtrend. Sometimes
a strong trend does not take hold after a channel breakout and prices oscillate
between the channel lines. Such trading ranges are marked by a relatively flat
moving average. The channel boundaries can then be used to identify overbought
and oversold levels for trading purposes.
Conclusions
Keltner Channels are a trend
following indicator designed to identify the underlying trend. Trend
identification is more than half the battle. The trend can be up, down or flat.
Using the methods described above, traders and investors can identify the trend
to establish a trading preference. Bullish trades are favored in an uptrend and
bearish trades are favored in a downtrend. A flat trend requires a more nimble
approach because prices often peak at the upper channel line and trough at the
lower channel line. As with all analysis techniques, Keltner Channels should be
used in conjunction with other indicators and analysis.
Introduction
Developed by Gerald Appel in
the late seventies, the Moving Average Convergence-Divergence (MACD) indicator
is one of the simplest and most effective momentum indicators available. The
MACD turns two trend-following indicators, moving averages, into a momentum
oscillator by subtracting the longer moving average from the shorter moving
average. As a result, the MACD offers the best of both worlds: trend following
and momentum. The MACD fluctuates above and below the zero line as the moving
averages converge, cross and diverge. Traders can look for signal line
crossovers, centerline crossovers and divergences to generate signals.
The values of 12, 26 and 9 are
the typical setting used with the MACD, however other values can be substituted
depending on your trading style and goals.
Interpretation
As its name implies, the MACD
is all about the convergence and divergence of the two moving averages.
Convergence occurs when the moving averages move towards each other. Divergence
occurs when the moving averages move away from each other. The shorter moving
average (12-day) is faster and responsible for most MACD movements. The longer
moving average (26-day) is slower and less reactive to price changes in the
underlying security.
The MACD Line oscillates above
and below the zero line, which is also known as the centerline. Positive values
increase as the shorter EMA diverges further from the longer EMA. This means
upside momentum is increasing.
Negative values increase as the shorter EMA diverges further below the longer
EMA. This means downside momentum is increasing.
Signal Line Crossovers
As a moving average of the
indicator, it trails the MACD and makes it easier to spot MACD turns. A bullish
crossover occurs when the MACD turns up and crosses above the signal line. A
bearish crossover occurs when the MACD turns down and crosses below the signal
line. Crossovers can last a few days or a few weeks, it all depends on the
strength of the move.
Due diligence is required
before relying on these common signals. Signal line crossovers at positive or
negative extremes should be viewed with caution. Even though the MACD does not
have upper and lower limits, chartists can estimate historical extremes with a
simple visual assessment. It takes a strong move in the underlying security to
push momentum to an extreme. Even though the move may continue, momentum is
likely to slow and this will usually produce a signal line crossover at the
extremities. Volatility in the underlying security can also increase the number
of crossovers.
Centerline Crossovers
Centerline crossovers are the
next most common MACD signals. A bullish centerline crossover occurs when the
MACD Line moves above the zero line to turn positive. A bearish centerline
crossover occurs when the MACD moves below the zero line to turn negative.
Centerline crossovers can last a few days or a few months. It all depends on the
strength of the trend. The MACD will remain positive as long as there is a
sustained uptrend. The MACD will remain negative when there is a sustained
downtrend.
Divergences
Divergences form when the MACD
diverges from the price action of the underlying security. A bullish divergence
forms when a security records a lower low and the MACD forms a higher low. The
lower low in the security affirms the current downtrend, but the higher low in
the MACD shows less downside momentum. Despite less downside momentum, downside
momentum is still outpacing upside momentum as long as the MACD remains in
negative territory. Slowing downside momentum can sometimes foreshadows a trend
reversal or a sizable rally.
A bearish divergence forms
when a security records a higher high and the MACD Line forms a lower high. The
higher high in the security is normal for an uptrend, but the lower high in the
MACD shows less upside momentum. Even though upside momentum may be less, upside
momentum is still outpacing downside momentum as long as the MACD is positive.
Waning upward momentum can sometimes foreshadow a trend reversal or sizable
decline.
Divergences should be taken
with caution. Bearish divergences are commonplace in a strong uptrend, while
bullish divergences occur often in a strong downtrend. Yes, you read that right.
Uptrends often start with a strong advance that produces a surge in upside
momentum (MACD). Even though the uptrend continues, it continues at a slower
pace that causes the MACD to decline from its highs. Upside momentum may not be
as strong, but upside momentum is still outpacing downside momentum as long as
the MACD Line is above zero. The opposite occurs at the beginning of a strong
downtrend.
Conclusions
The MACD indicator is special
because it brings together momentum and trend in one indicator. This unique
blend of trend and momentum can be applied to daily, weekly or monthly charts.
The standard setting for MACD is the difference between the 12 and 26-period
EMAs. Chartists looking for more sensitivity may try a shorter short-term moving
average and a longer long-term moving average.
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Money Flow
Index (MFI) |
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Introduction
The Money Flow Index (MFI) is
an oscillator that uses both price and volume to measure buying and selling
pressure. MFI starts with the typical price for each period. Money flow is
positive when the typical price rises (buying pressure) and negative when the
typical price declines (selling pressure). A ratio of positive and negative
money flow is then plugged into an RSI formula to create an oscillator that
moves between zero and one hundred. As a momentum oscillator tied to volume, the
Money Flow Index (MFI) is best suited to identify reversals and price extremes
with a variety of signals.
Interpretation
The Money Flow Index (MFI) can
be interpreted similar to RSI. The big difference is, of course, volume. Because
volume is added to the mix, the Money Flow Index will act a little differently
than RSI. Theories suggest that volume leads prices. RSI is a momentum
oscillator that already leads prices. Incorporating volume can increase this
lead time. There are three basic signals using the Money Flow Index. First,
chartists can look for overbought or oversold levels to warn of unsustainable
price extremes. Second, bullish and bearish divergence can be used to anticipate
trend reversals. Third, failure swings at 80 or 20 can also be used to identify
potential price reversals.
Overbought/Oversold
Overbought and oversold levels
can be used to identify unsustainable price extremes. Typically, MFI above 80 is
considered overbought and MFI below 20 is considered oversold. Strong trends can
present a problem for these classic overbought and oversold levels. MFI can
become overbought (>80) and prices can simply continue higher when the uptrend
is strong. Conversely, MFI can become oversold (<20) and prices can simply
continue lower when the downtrend is strong.
Divergences and Failures
Failure swings and divergences
can be combined to create more robust signals. A bullish failure swing occurs
when MFI becomes oversold below 20, surges above 20, holds above 20 on a
pullback and then breaks above its prior reaction high. A bullish divergence
forms when prices move to a lower low, but the indicator forms a higher low to
show improving money flow or momentum. A bearish failure swing occurs when MFI
becomes overbought above 80, plunges below 80, fails to exceed 80 on a bounce
and then breaks below the prior reaction low. A bearish divergence forms when
the stock forges a higher high and the indicator forms a lower high, which
indicates deteriorating money flow or momentum.
Conclusions
The Money Flow Index is a
rather unique indicator that combines momentum and volume with an RSI formula.
RSI momentum generally favors the bulls when the indicator is above 50 and the
bears when below 50. Even though MFI is considered a volume-weighted RSI, using
the centerline to determine a bullish or bearish bias does not work as well.
Instead, MFI is better suited to identify potential reversals with
overbought/oversold levels, bullish/bearish divergences and bullish/bearish
failure swings. As with all indicators, MFI should not be used by itself. A pure
momentum oscillator, such as RSI, or pattern analysis can be combined with MFI
to increase signal robustness.
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Moving Average
Envelope |
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Introduction
Moving Average Envelopes are
percentage-based envelopes set above and below a moving average. The moving
average, which forms the base for this indicator, can be a simple or exponential
moving average. Each envelope is then set the same percentage above or below the
moving average. This creates parallel bands that follow price action. With a
moving average as the base, Moving Average Envelopes can be used as a trend
following indicator. However, this indicator is not limited to just trend
following. The envelopes can also be used to identify overbought and oversold
levels when the trend is relatively flat.
Interpretation
Indicators based on channels,
bands and envelopes are designed to encompass most price action. Therefore,
moves above or below the envelopes warrant attention. Trends often start with
strong moves in one direction or another. A surge above the upper envelope shows
extraordinary strength, while a plunge below the lower envelope shows
extraordinary weakness. Such strong moves can signal the end of one trend and
the beginning of another.
With a moving average as its
foundation, Moving Average Envelopes are a natural trend following indicator. As
with moving averages, the envelopes will lag price action. The direction of the
moving average dictates the direction of the channel. In general, a downtrend is
present when the channel moves lower, while an uptrend exists when the channel
moves higher. The trend is flat when the channel moves sideways.
Sometimes a strong trend does
not take hold after an envelope break and prices move into a trading range. Such
trading ranges are marked by a relatively flat moving average. The envelopes can
then be used to identify overbought and oversold levels for trading purposes. A
move above the upper envelope denotes an overbought situation, while a move
below the lower envelope marks an oversold condition.
Conclusions
Moving Average Envelopes are
mostly used as a trend following indicator, but can also be used to identify
overbought and oversold conditions. After a consolidation period, a strong
envelope break can signal the start of an extended trend. Once an uptrend is
identified, chartists can turn to momentum indicators and other techniques to
identify oversold readers and pullbacks within that trend. Overbought conditions
and bounces can be used as selling opportunities within a bigger downtrend. In
the absence of strong trend, the Moving Average Envelopes can be used like the
Percent Price Oscillator (ROC). Moves above the upper envelope signal overbought
readings, while moves below the lower envelope signal oversold readings. It is
also important to incorporate other aspects of technical analysis to confirm
overbought and oversold reading. Resistance and bearish reversals patterns can
be used to corroborate overbought readings. Support and bullish reversal
patterns can be used to affirm oversold conditions.
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On Balance
Volume (OBV) |
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Introduction
On Balance Volume (OBV)
measures buying and selling pressure as a cumulative indicator that adds volume
on up days and subtracts volume on down days. OBV was developed by Joe
Granville. It was one of the first
indicators to measure positive and negative volume flow. Chartists can look for
divergences between OBV and price to predict price movements or use OBV to
confirm price trends. The On Balance Volume (OBV) line is simply a running total
of positive and negative volume. A period's volume is positive when the close is
above the prior close. A period's volume is negative when the close is below the
prior close.
Interpretation
It is theorized that volume
precedes price. OBV rises when volume on up days outpaces volume on down days.
OBV falls when volume on down days is stronger. A rising OBV reflects positive
volume pressure that can lead to higher prices. Conversely, falling OBV reflects
negative volume pressure that can foreshadow lower prices. Expect prices to move
higher if OBV is rising while prices are either flat or moving down. Expect
prices to move lower if OBV is falling while prices are either flat or moving
up.
The absolute value of OBV is
not important. Chartists should instead focus on the characteristics of the OBV
line. First define the trend for OBV. Second, determine if the current trend
matches the trend for the underlying security. Third, look for potential support
or resistance levels. Once broken, the trend for OBV will change and these
breaks can be used to generate signals. Also notice that OBV is based on closing
prices. Therefore, closing prices should be considered when looking for
divergences or support/resistance breaks. And finally, volume spikes can
sometimes throw off the indicator by causing a sharp move that will require a
settling period.
Conclusions
On Balance Volume (OBV) is a
simple indicator that uses volume and price to measure buying pressure and
selling pressure. Buying pressure is evident when positive volume exceeds
negative volume and the OBV line rises. Selling pressure is present when
negative volume exceeds positive volume and the OBV line falls. Chartists can
use OBV to confirm the underlying trend or look for divergences that may
foreshadow a price change. As with all indicators, it is important to use OBV in
conjunction with other aspects of technical analysis. It is not a stand alone
indicator. OBV can be combined with basic pattern analysis or to confirm signals
from momentum oscillators.
Introduction
Calculated as:(High + Low ) /
2
The line is plotted on the
price chart and can be used as a filter for trend indicators. For example A
Single Moving Average System can be used with median price as a filter. Long and
short trades are signaled when median price crosses the moving average.
Conclusions
By itself it shows the mid
point of a bar. This can be of very high value for a trader who wants to know
what is the current days trend. Current prices above or below the Median price
will indicate strength in that direction.
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Price ROC -
Rate of Change% |
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Introduction
The Rate-of-Change (ROC)
indicator, which is also referred to as simply Momentum, is a pure momentum
oscillator that measures the percent change in price from one period to the
next. The ROC calculation compares the current price with the price "n" periods
ago. The plot forms an oscillator that fluctuates above and below the zero line
as the Rate-of-Change moves from positive to negative. As a momentum oscillator,
ROC signals include centerline crossovers, divergences and overbought-oversold
readings. Divergences fail to foreshadow reversals more often than not so this
article will forgo a discussion on divergences. Even though centerline
crossovers are prone to whipsaw, especially short-term, these crossovers can be
used to identify the overall trend. Identifying overbought or oversold extremes
comes natural to the Rate-of-Change oscillator.
Interpretation
As noted above, the
Rate-of-Change indicator is momentum in its purest form. It measures the
percentage increase or decrease in price over a given period of time. Think of
its as the rise (price change) over the run (time). In general, prices are
rising as long as the Rate-of-Change remains positive. Conversely, prices are
falling when the Rate-of-Change is negative. ROC expands into positive territory
as an advance accelerates. ROC dives deeper into negative territory as a decline
accelerates.
Trend Identification - Even
though momentum oscillators are best suited for trading ranges or zigzag trends,
they can also be used to define the overall direction of the underlying trend.
Conclusions
The Rate-of-Change oscillator
measures the speed at which prices are changing. An upward surge in the
Rate-of-Change reflects a sharp price advance. A downward plunge indicates a
steep price decline. Even though chartists can look for bullish and bearish
divergences, these formations can be misleading because of sharp moves.
Sustained advances often start with a big surge out of the gate. Subsequent
advances are usually less sharp and this causes a bearish divergence to form in
the Rate-of-Change oscillator. It is important to remember that prices are
constantly increasing as long as the Rate-of-Change remains positive. Positive
readings may be less than before, but a positive Rate-of-Change still reflects a
price increase, not a price decline. Like all technical indicator, the
Rate-of-Change oscillator should be used in conjunction with other aspects of
technical analysis.
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Relative
Strength Index (RSI) |
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Introduction
Developed J. Welles Wilder,
the Relative Strength Index (RSI) is a momentum oscillator that measures the
speed and change of price movements. RSI oscillates between zero and 100.
Traditionally, and according to Wilder, RSI is considered overbought when above
70 and oversold when below 30. Signals can also be generated by looking for
divergences, failure swings and centerline crossovers. RSI can also be used to
identify the general trend.
RSI is an extremely popular
momentum indicator that has been featured in a number of articles, interviews
and books over the years.
Interpretation
The default look-back period
for RSI is 14, but this can be lowered to increase sensitivity or raised to
decrease sensitivity. 10-day RSI is more likely to reach overbought or oversold
levels than 20-day RSI. The look-back parameters also depend on a security's
volatility.
Overbought-Oversold
RSI is considered overbought
when above 70 and oversold when below 30. These traditional levels can also be
reconsidered to better fit the security or analytical requirements. Raising
overbought to 80 or lowering oversold to 20 will reduce the number of
overbought/oversold readings.
Divergences
Divergences signal a potential
reversal point because directional momentum does not confirm price. A bullish
divergence occurs when the underlying security makes a lower low and RSI forms a
higher low. RSI does not confirm the lower low and this shows strengthening
momentum. A bearish divergence forms when the security records a higher high and
RSI forms a lower high. RSI does not confirm the new high and this shows
weakening momentum.
Conclusions
RSI is a versatile momentum
oscillator that has stood the test of time. Despite changes in volatility and
the markets over the years, RSI remains as relevant now as it was during
Wilder's days.
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Stochastics
Oscillator |
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Introduction
Developed by George C. Lane in
the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the
location of the close relative to the high-low range over a set number of
periods. According to an interview with Lane, the Stochastic Oscillator "doesn't
follow price, it doesn't follow volume or anything like that. It follows the
speed or the momentum of price. As a rule, the momentum changes direction before
price." As such, bullish and bearish divergences in the Stochastic Oscillator
can be used to foreshadow reversals. Because the Stochastic Oscillator is range
bound, is also useful for identifying overbought and oversold levels.
Interpretation
The Stochastic Oscillator
measures the level of the close relative to the high-low range over a given
period of time. The Stochastic Oscillator is above 50 when the close is in the
upper half of the range and below 50 when the close is in the lower half. Low
readings (below 20) indicate that price is near its low for the given time
period. High readings (above 80) indicate that price is near its high for the
given time period.
Overbought Oversold
As a bound oscillator, the
Stochastic Oscillator makes it easy to identify overbought and oversold levels.
The oscillator ranges from zero to one hundred. No matter how fast a security
advances or declines, the Stochastic Oscillator will always fluctuate within
this range. Traditional settings use 80 as the overbought threshold and 20 as
the oversold threshold. These levels can be adjusted to suit analytical needs
and security characteristics. Readings above 80 for the 20-day Stochastic
Oscillator would indicate that the underlying security was trading near the top
of its 20-day high-low range. Readings below 20 occur when a security is trading
at the low end of its high-low range.
Divergences
Divergences form when a new
high or low in price is not confirmed by the Stochastic Oscillator. A bullish
divergence forms when price records a lower low, but the Stochastic Oscillator
forms a higher low. This shows less downside momentum that could foreshadow a
bullish reversal. A bearish divergence forms when price records a higher high,
but the Stochastic Oscillator forms a lower high. This shows less upside
momentum that could foreshadow a bearish reversal. Once a divergence takes hold,
chartists should look for a confirmation to signal an actual reversal. A bearish
divergence can be confirmed with a support break on the price chart or a
Stochastic Oscillator break below 50, which is the centerline. A bullish
divergence can be confirmed with a resistance break on the price chart or a
Stochastic Oscillator break above 50.
50 is an important level to
watch. The Stochastic Oscillator moves between zero and one hundred, which makes
50 the centerline.
Conclusions
While momentum oscillators are
best suited for trading ranges, they can also be used with securities that
trend, provided the trend takes on a zigzag format. Pullbacks are part of
uptrends that zigzag higher. Bounces are part of downtrends that zigzag lower.
In this regard, the Stochastic Oscillator can be used to identify opportunities
in harmony with the bigger trend.
The indicator can also be used
to identify turns near support or resistance. Should a security trade near
support with an oversold Stochastic Oscillator, look for a break above 20 to
signal an upturn and successful support test. Conversely, should a security
trade near resistance with an overbought Stochastic Oscillator, look for a break
below 80 to signal a downturn and resistance failure.
The settings on the Stochastic
Oscillator depend on personal preferences, trading style and timeframe. A
shorter look-back period will produce a choppy oscillator with many overbought
and oversold readings. A longer look-back period will provide a smoother
oscillator with fewer overbought and oversold readings.
Like all technical indicators,
it is important to use the Stochastic Oscillator in conjunction with other
technical analysis tools. Volume, support/resistance and breakouts can be used
to confirm or refute signals produced by the Stochastic Oscillator.
Introduction
Developed by Larry Williams,
Williams %R is a momentum indicator that is the inverse of the Fast Stochastic
Oscillator. Also referred to as %R, Williams %R reflects the level of the close
relative to the highest high for the look-back period. In contrast, the
Stochastic Oscillator reflects the level of the close relative to the lowest
low. %R corrects for the inversion by multiplying the raw value by -100.
Williams %R oscillates from 0
to -100. Readings from 0 to -20 are considered overbought. Readings from -80 to
-100 are considered oversold.
Interpretation
Similar to the Stochastic
Oscillator, Williams %R reflects the level of the close relative to the high-low
range over a given period of time. The centerline, -50, is an important level to
watch. Williams %R moves between 0 and -100, which makes -50 the midpoint. Low
readings (below -80) indicate that price is near its low for the given time
period. High readings (above -20) indicate that price is near its high for the
given time period.
Overbought Oversold
As a bound oscillator,
Williams %R makes it easy to identify overbought and oversold levels. The
oscillator ranges from 0 to -100. No matter how fast a security advances or
declines, Williams %R will always fluctuate within this range. Traditional
settings use -20 as the overbought threshold and -80 as the oversold threshold.
These levels can be adjusted to suit analytical needs and security
characteristics. Readings above -20 for the 14-day Williams %R would indicate
that the underlying security was trading near the top of its 14-day high-low
range. Readings below -80 occur when a security is trading at the low end of its
high-low range.
Conclusions
Williams %R is a momentum
oscillator that measures the level of the close relative to the high-low range
over a given period of time. Chartists can also use %R to gauge the six month
trend for a security. 125-day %R covers around 6 months. Prices are above their
6-month average when %R is above -50, which is consistent with an uptrend.
Readings below -50 are consistent with a downtrend. In this regard, %R can be
used to help define the bigger trend (six months). Like all technical
indicators, it is important to use the Williams %R in conjunction with other
technical analysis tools. Volume, chart patterns and breakouts can be used to
confirm or refute signals produced by Williams %R.