Absolute Breadth Index
A market momentum indicator that measures how much activity, volatility and change is taking place on the NYSE while ignoring the direction prices are headed. High readings indicate above average market activity and change, while low readings indicate lack of change. Historically, values above 450 typically lead to higher prices three to 12 months later.
The Absolute Breadth Index is calculated by taking the absolute value of the difference between NYSE Advancing Issues and Declining Issues.
Accumulation/Distribution Line ( AD )
The Accumulation/Distribution Line was developed by Marc Chaikin to assess the cumulative flow of money into and out of a security. He decided to focus on the price action for a given period (day, week, month) and derived a formula to calculate a value based on the location of the close, relative to the range for the period. This is the “Close Location Value” or CLV. The CLV ranges from plus one to minus one with the center point at zero.
The signals for the Accumulation/Distribution Line are fairly straightforward and involve divergence or confirmation. A bullish signal is given when the Accumulation/Distribution Line forms a positive divergence. Be wary of weak positive divergences that fail to make higher reaction highs. A two-week positive divergence should be suspect. However, a multi-month positive divergence deserves serious attention.
The Accumulation/Distribution Line can also be used to confirm the strength or sustainability behind an advance. In a healthy advance, the Accumulation/Distribution Line should remain up or at least move in an uptrend. If the stock is moving up at a rapid pace, but the Accumulation/Distribution Line has trouble making higher highs or starts going sideways, buying pressure is relatively weak.
The Accumulation/Distribution Line can at time have problems detecting subtle changes in volume flows. The rate of change in a downtrend could be slowing, but it may be impossible to detect until the Accumulation/Distribution Line turns up. This drawback has been addressed in the form of the Chaikin Oscillator or Chaikin Money Flow.
The number of stocks advancing divided by the number of stocks declining over a given time period.
Each day’s declining issues are subtracted from the day’s advancing issues. The difference is added to, or subtracted from if negative, a running total. Failure of the A/D Line to confirm a new high is a sign of weakness. Failure of the line to confirm a new low is a sign of strength.
A market indicator that illustrates the relationship between the number of stocks that increase or decrease in price (advancing/declining issues) and the volume associated with stocks that increase or decrease in price (advancing/declining volume). To calculate it, divide the Advance/Decline Ratio by the Upside/Downside Ratio.The Index was developed by Richard Arms in 1967. It has also been known as the TRIN, an acronym for TRading INdex. According to Arms, a 10-day average of the Arms Index above 1.20 is considered oversold, while a 10-day Arms value below .70 is overbought.
Aroon Indicator (Aroon)
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 closes at a new high for the given 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.
When Aroon(up) and Aroon(down) are moving together, there is no clear trend (the price is moving sideways, or about to move sideways).
When the Aroon(up) is below 50, it is an indication that the uptrend is losing its momentum, while when the Aroon(down) is below 50, it is an indication that the downtrend is losing its momentum.
When the Aroon(up) or Aroon(down) are above 70, it indicates a strong trend in the same direction, while when the value is below 30, it indicates a coming trend in the opposite direction.
Aroon Oscillator (AroonOsc)
The Aroon Oscillator was 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.
A positive value indicates an upward trend (or coming trend), and a negative value indicates a downward trend. The higher the absolute value of the oscillator, the stronger the indication of a trend.
A bullish chart pattern characterized by a series of lows, each successively higher than the last, and a series of highs that are at approximately the same level. The resulting formation is a triangle indicating that buyers are controlling the market at progressively higher prices. customers.
Average Directional Index (ADX)
Developed by J. Welles Wilder, the Average Directional Movement Index (ADX) is an indicator for use with the Directional Movement Index and quantifies the strength and direction of a trend. The ADX consists of three components: the plus Directional Indicator (+DI), the minus Directional Indicator (-DI) and the Average Directional Indicator. The ADX is simply a modified moving average of DX.
To calculate up or down directional movement in a trend, a range is determined by comparing today’s high and low with yesterdays close. If the largest part of today’s range is above yesterday’s range, the directional movement is plus. If the largest part of today’s range is below yesterday’s range, the directional movement is minus. If today’s range is within yesterday’s range, then directional movement is defined as zero. The average of the directional movement indicators is the ADX.
Read the ADX like an oscillator. A high positive value would be bullish. A low negative value is interpreted as bearish.
Average True Range (ATR)
Average True Range or ATR is a measurement of volatility. It measures the average of true price ranges over time. The True Range is the greatest distance between today’s high to today’s low, yesterday’s close to today’s high, or yesterday’s close to today’s low. The Average True Range is a moving average of the True Ranges.
High ATR values often occur at market bottoms following a “panic” sell-off. Low Average True Range values are often found during extended sideways movement, like as those found at market tops or after consolidation periods. True Range is used in Welles Wilder’s Directional Movement indicator as well as Donald Mart’s Master Trading Formula and is a common volatility ratio. The ATR can be used in a channel breakout method of trading by adding or subtracting from the previous bar’s close or the current bar’s open.
Bollinger Bands (BB)
Similar to Moving Average Envelopes, Bollinger Bands are plotted at 2 standard deviations above and below a 20-day exponential moving average. As standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods.
As a rule, prices are considered to be overextended on the upside (“overbought”) when they touch the upper band. They are considered overextended on the downside (“oversold”) when they touch the lower band. Using two standard deviations ensures that 95% of the price data will fall between the two trading bands.
The simplest way to use Bollinger Bands is to use the upper and lower bands as price targets. In other words, if prices bounce off the lower band and cross above the 20 day average, then the upper band becomes the upper price target.
A crossing below the 20 day average would identify the lower band as the downside target. In a strong uptrend, prices will usually fluctuate between the upper band and the 20 day average. In that case, a crossing below the 20 day average warns of a trend reversal to the downside.
As Bollinger Bands creator John Bollinger noted – 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.
Bollinger Band Width (BBWidth)
The Bollinger Band Width indicator charts the width of the Bollinger Bands. When the Bollinger Band Width increases in value, it indicates that the volatility of the underlying stock has also increased.
Created by John Bollinger, 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.
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.
Bullish-Bearish Indicator (BBI)
A Psychological Market Indicator used to help determine when a Market Bottom or Top is nearing. The Bullish-Bearish Indicator shows the % of Bullish and Bearish market components.
Generally when there is a large difference ( >30%) between the % of Bullish and Bearish components there is an excessive amount of Bullishness in the market which usually is indicative of a nearing top, and the reverse would hold true for Bearish – a nearing bottom.
A charting method developed in Japan in the 1700s. The price range between the open and the close is plotted as a rectangle on the line. If the market closes above the open, the body of the rectangle is white. If the close is below the open, the body of the rectangle is black. The high and low for the time period are plotted as lines, called shadows, extending from the rectangle.
Chaikin Money Flow (CMF)
The Chaikin Money Flow is based upon the assumption that a bullish stock will have a relatively high close price within its daily range and have increasing volume. However, if a stock consistently closed with a relatively low close price within its daily range with high volume, this would be indicative of a weak security. There is pressure to buy when a stock closes in the upper half of a period’s range and there is selling pressure when a stock closes in the lower half of the period’s trading range.
An obvious bearish signal is when Chaikin Money Flow is less than zero. A reading of less than zero indicates that a security is under selling pressure or experiencing distribution.
A second potentially bearish signal is the length of time that Chaikin Money Flow has remained less than zero. The longer it remains negative, the greater the evidence of sustained selling pressure or distribution.
The third potentially bearish signal is the degree of selling pressure. This can be determined by the oscillator’s absolute level. Readings on either side of the zero line or plus or minus 0.10 are usually not considered strong enough to warrant either a bullish or bearish signal. Once the indicator moves below -0.10, the degree selling pressure begins to warrant a bearish signal. Likewise, a move above +0.10 would be significant enough to warrant a bullish signal.
Marc Chaikin considers a reading below -0.25 to be indicative of strong selling pressure. Conversely, a reading above +0.25 is considered to be indicative of strong buying pressure.
The Chaikin Money Flow is based upon the assumption that a bullish stock will have a relatively high close price within its daily range and have increasing volume. This condition would be indicative of a strong security. However, if it consistently closed with a relatively low close price within its daily range and high volume, this would be indicative of a weak security.
Chaikin’s Volatility (VOLATI)
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.
A price range at which previous heavy volume trading has occurred. It is considered a likely price point for future support or resistance.
Commodity Channel Index (CCI)
The CCI or Commodity Channel Index is a means by which the variation of a security’s price is calculated from its statistical mean.
Much like the Average Directional Movement Index, the CCI can help give a valuable measurement of the overall trendiness of a market. The faster the CCI is accelerating, the more strongly the market is trending. While it is perhaps mathematically possible for the CCI to move upward while the market does not, this is unlikely.
Typically oscillating between +100 and -100, a CCI reading above +100 implies an overbought condition (and a pending price correction) while readings below -100 imply an oversold condition (and a pending rally).
Keep in mind that the CCI can provide important information to a trader even when it is not giving entry signals. If a market stays inside the +/-100 range most of the time, it’s demonstrating the absence of a trend, so it might be best to avoid that market or use a countertrend trading strategy.
Occurs when the action of one indicator confirms the action of another. The lack of such confirmation is called divergence.
The inverse of an Ascending Triangle. A bearish chart pattern characterized by a series of highs, each successively lower than the last, and a series of lows that are at approximately the same level. The resulting formation is a triangle indicating that sellers are controlling the market at progressively lower prices.
Detrended Price Oscillator (DPO)
The Detrended Price Oscillator is a tool that smoothes the trend in prices, allowing you to more easily identify cycles and overbought/oversold levels.
If you think of long-term cycles as made up of a series of short-term cycles, then analyzing these shorter term components can be helpful in identifying major turning points.
Note that as the oscillator moves above and below the zero line, minor peaks in the DPO will usually coincide with minor peaks in price. Longer-term price trends are not reflected as the 20-day DPO removes cycles of more than 20 days.
The real power of the Detrended Price Oscillator is in identifying turning points in longer cycles:
– When Detrended Price Oscillator shows a higher trough – expect an upturn in the intermediate cycle;
– When Detrended Price Oscillator experiences a lower peak – expect a downturn.
Directional Movement Index (DMI)
Directional movement is a system for providing trading signals to be used for price breaks from a trading range. The system involves 5 indicators which are the Directional Movement Index (DX), the plus Directional Indicator (+DI), the minus Directional Indicator (-DI), the average Directional Movement (ADX) and the Directional movement rating (ADXR). The system was developed by J. Welles Wilder and is explained thoroughly in his book, New Concepts in Technical Trading Systems .
The basic Directional Movement Trading system involves plotting the 14day +DI and the 14 day -DI on top of each other. When the +DI rises above the -DI, it is a bullish signal. A bearish signal occurs when the +DI falls below the -DI. To avoid whipsaws, Wilder identifies a trigger point to be the extreme price on the day the lines cross. If you have received a buy signal, you would wait for the security to rise above the extreme price (the high price on the day the lines crossed). If you are waiting for a sell signal the extreme point is then defined as the low price on the day’s the line cross.
Occurs when the action of one indicator runs counter to another indicator. These contradictions frequently signal reversals
Single candlestick pattern that forms when the open and close are equal or almost equal. The resulting candlestick resembles a cross and typically indicates market indecision, or hesitation, regarding the current trend.
A bullish chart pattern in which two successive pullbacks both terminate at approximately the same level. When the pattern resolves itself, with a rise above the high point between the lows, it frequently resembles the letter “W”.
The inverse of the Double Bottom. A bearish chart pattern in which two successive tops both terminate at approximately the same level. When the pattern resolves itself, with a drop below the low point between the highs, it frequently resembles the letter “M”. Elliot Wave: The Elliot Wave Theory was originally published by Ralph Nelson Elliot in 1939. It is a theory of cyclical movements of prices. The theory holds that the stock market follows a pattern of five waves up and three waves down to form a complete cycle.
Envelopes (Trading Bands) (ENV)
Envelopes represent bands that are plotted in a certain, identical relationship above and below the Moving Average. Envelopes are a very complex theme with many interpretation and trading rules. Basically, envelopes capture a significant part of price movements. Concrete trading signals are released if prices approach or move away form their envelope. Professional plots envelopes around a Moving Average in a constant percentage distance. Hence they are added to or subtracted from this average. Both envelope lines thus define the prevailing trading range.
The Moving Average Envelope study is a derivative of the Moving Average study. The price band has two lines that are equal percentage distance from the Simple Moving Average. The Moving Average line is not visible.
While several different trading rules are available, the most simple approach uses the price band as an entry and exit point. When price penetrates the upper price band, you initiate a long position or buy. If you have an existing short position, you close out shorts and go long. Conversely, when prices penetrate the lower price band, you close out long positions and go short.
Exponential Moving Average
Calculated by applying a percentage of today’s closing price to yesterday’s moving average value. As a result, the most recent market action is weighted more heavily enabling the EMA to capture near-term trend changes earlier than a simple moving average. The exponential moving averages contrasts with the simple moving average in which all price data has an equal weight in the computation of the average with the oldest value removed as each new value is added.
The Fibonacci number sequence (1,2,3,5,8,13,21,34,55,89,144,…) is derived by adding the first two numbers to arrive at the third. The ratio of any number to the next number is 61.8 percent, which is frequently characterized as a major Fibonacci retracement number. The inverse of 61.8 percent is 38.2 percent, also characterized as a major Fibonacci retracement number.
A tool used to identify areas where a counter move will stop. Retracements are displayed by first drawing a trendline between two extreme points, a trough and an opposing peak. A series of horizontal lines are then drawn intersecting the trendline at the Fibonacci levels. The most common levels used in retracement analysis are 61.8%, 38.2% and 50%.
A brief continuation pattern within a steep advance or decline. It generally takes the form of a compact rectangle, or parallelogram, tilted against the prevailing trend and resembling a flag.
A gap occurs when the price opens above the high of the previous period and trades higher, or when the price opens under the low of the previous period and trades lower. The result is a “blank spot” on the chart designating prices that were not traded. Gaps are especially significant when accompanied by an increase in volume.
Head and Shoulders Top
A bearish pattern characterized by a series of three peaks, the first and third being lower than the middle and representing the shoulders. Volume is typically heavy on the first peak and declines on the next two. The pattern is resolved by the breaking of the “neckline” — an extension of the line connecting the troughs between the three peaks — accompanied by heavy volume.
A day in which the total range of price is within the range of the previous day’s price range.
A chart pattern in which there is an initial gap in the direction of the prevailing trend. Prices then trade in a narrow range for a period followed by a concluding gap counter to the prevailing trend. The result is an “island” of prices indicating a reversal of the previous trend.
Pattern that signals a reversal of the prevailing trend. The reliability of a pattern is tied to the strength of the prior trend. The stronger the trend, the more reliable the pattern.
For a key reversal to occur after an uptrend:
The Open must be above yesterday’s Close,
The day must make a new High, and
The Close must be below yesterday’s Low.
For a key reversal to occur after a down-trend:
The Open must be below yesterday’s Close,
The day must make a new Low, and
The Close must be above yesterday’s High.
Linear Regression Channels (LRC)
A technical indicator used to determine the trend a security is developing and the likely price range that will take place within that trend. The channel is created using a price history chart and consists of an upper line, a middle line, and a lower line. The upper channel line is created by connecting a series of recent high price points in a straight line, the middle line by connecting intermediate highs and lows, and the lower channel line by connecting a series of low price points.
Primarily the top of a channel line tends to act as a resistance level much like a moving average might. When the stock hits the upper line, it usually moves down or “regresses” to the lower or middle line. Consequently, the lower end of the channel tends to act as support. The middle line acts as a median, giving a central point to watch how the stock reacts – does it tend to gravitate more towards the lower line or the upper line of the channel?
The channel provides a picture of the overall trend of a stock, whether it is in an up trend, downtrend, or just consolidating.
The extent to which securities prices reflect what’s known and adjust promptly to what becomes known. With modern telecommunications, a vigorous business press and a large number of buyers and sellers, American securities markets are pretty efficient, but there is perennial debate surrounding the question: how efficient? Absolutists (advocates of the efficient market hypothesis) contend that the markets are utterly efficient, meaning that all available information is already discounted in prices. The implication is that it isn’t possible for an investor to “”beat”” the market without some secret inside information, or perhaps clairvoyance. If you’re in this camp, index investing makes a whole lot of sense, and indeed, it’s awfully hard for most money managers to beat the market consistently. At the other end of the spectrum, value investors contend that intensive spadework can turn up undervalued stocks that have been overlooked by the market at large. A number of investors, such as Warren Buffett and Peter Lynch, evidently do accomplish this on a consistent basis.
Mass Index (MASS)
The Mass Index was developed by Donald Dorsey to identify trend reversals by using the changes of daily price ranges to identify reversals in trends. As the price ranges narrow, the Mass Index decreases. As the price ranges widen, the Mass Index increases.
A significant pattern to watch for is the “reversal bulge.” These occur when on a 25-period plot the Mass Index surpasses 27 then falls past 26.5.
A 9-period Exponential Moving Average of prices is often used to determine if the reversal bulge indicates a buying or selling. If a reversal bulge occurs, buy if the moving average is trending down (in anticipation of the reversal) and sell if it is trending up.
By measuring the amount that a security’s price has changed over a given time span, the Momentum indicator provides an indication of a market’s velocity and to some degree, a measure of the extent to which a trend still holds true. It can also be helpful in spotting likely reversal points.
While the mathematics are straightforward (subtract the closing price n days ago from the closing price today), do not underrate its value because of its simplicity.
Use the Momentum indicator as a trend-following oscillator similar to the MACD and buy when the indicator bottoms and turns up. Sell when the indicator peaks and turns down. When the Momentum indicator reaches extremely high or low values (relative to historical values) assume a continuation of the current trend.
A second usage for the Momentum indicator is as a leading indicator. As a market peaks, the Momentum indicator will climb sharply before falling off. At a market bottom, the plot will drop sharply and then climb well ahead of prices.
The moving average is used to observe price changes. The effect of the moving average is to smooth the price movement so that the longer term trend becomes less volatile and therefore more obvious. When the price rises above the moving average, it indicates that investors are becoming bullish on the commodity. When the prices falls below, it indicates a bearish commodity. As well, when a moving average crosses below a longer term moving average, the study indicates a down turn in the market. When a short term moving average crosses above a longer term moving average, this indicates an upswing in the market. The longer the period of the moving average, the smoother the price movement is. Longer moving averages are used to isolate long term trends.
Moving Average Convergence Divergence (MACD)
The Moving Average Convergence/Divergence indicator (MACD) is calculated by subtracting the value of a 26-period exponential moving average from a 12-period exponential moving average (EMA). A 9-period dotted exponential moving average (the “signal line”) of the difference between the 26 and 12 period EMA is used as the signal line.
The basic MACD trading rule is to sell when the MACD falls below its 9 day signal line and to buy when the MACD rises above the 9 day signal line. Traders sometimes vary the calculation period of the signal line and may use different moving average lengths in calculating the MACD dependent on the security and trading strategy.
On Balance Volume
A price/volume indicator in which the volume for a given period, usually a day, is added to a cumulative total if the price rose, and subtracted if the price fell. No entry is made if the price was unchanged in the period. Developed and popularized by Joseph Granville in the early 1960s.
A market condition wherein a stock, sector or index has extended outside its normal range to the upside. Often accompanied by increased volume and a string of consecutive positive sessions, the condition implies a near term reversal is likely.
The reverse of overbought. A market condition wherein a stock, sector or index has extended outside its normal range to the downside. Often accompanied by increased volume and a string of consecutive negative sessions, the condition implies a near term reversal is likely.
Parabolic SAR (SAR)
The Parabolic Time/Price System, developed by Welles Wilder, is used to set trailing price stops and is sometimes referred to as the “SAR” (stop-and-reversal), Parabolic SAR is more popular for setting stops than for establishing direction or trend. Wilder recommended establishing the trend first, and then trading with Parabolic SAR in the direction of the trend. If the trend is up, buy when the indicator moves below the price. If the trend is down, sell when the indicator moves above the price.
The dotted lines below the price establish the trailing stop for a long position and the lines above establish the trailing stop for a short position. At the beginning of the move, the Parabolic SAR will provide a greater cushion between the price and the trailing stop. As the move gets underway, the distance between the price and the indicator will shrink, thus making for a tighter stop-loss as the price moves in a favorable direction.
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.
There are two variables: the step and the maximum step. The higher the step is set, the more sensitive the indicator will be to price changes. If the step is set too high, the indicator will fluctuate above and below the price too often, making interpretation difficult. The maximum step controls the adjustment of the SAR as the price moves. The lower the maximum step is set, the further the trailing stop will be from the price. Wilder recommends setting the step at 2 and the maximum step at 20.
For additional information along with the calculation please refer to “New Concepts in Technical Trading Systems” by Welles Wilder.
A continuation pattern that resembles a small symmetrical triangle. It typically designates a consolidation period before the predominant trend resumes.
R-Squared ranges from 0 to 100 and tells what percentage of a fund’s movements are explained by movements in its benchmark index.
An R-Squared of 100 means that all movements of a fund are completely explained by movements in the index. Thus, an index fund that invests only in S&P 500 stocks will have an R-Squared very close to 100. Conversely, a low R-Squared value indicates that very few of the fund’s movements are explained by movements in its benchmark index. Therefore, R-Squared can be used to ascertain the significance of a particular beta or alpha. Generally, a higher R-Squared will indicate a more useful beta figure. If the R-Squared is lower, then the beta is less relevant to the fund’s performance.
A theory that says technical analysis is worthless because the market is simply responding to information as it becomes available, and that whatever has come before is meaningless for predicting what’s ahead. A leading advocate is Burton Malkiel, but the theory actually goes back to the dawn of the 20th century. In my experinece, as a system developer, I feel the theory is full of shit.
The difference between the high and the low price recorded over a given period.
A price or level above the current price at which there is a supply of stock waiting to be sold. Previous trading at that level suggests there would be resistance to the price moving significantly higher.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is one of the most popular overbought/oversold (OB/OS) indicators. The RSI is basically an internal strength index which is adjusted on a daily basis by the amount by which the market rose or fell. It is most commonly used to show when a market has topped or bottomed. A high RSI occurs when the market has been rallying sharply and a low RSI occurs when the market has been selling off sharply. The RSI is expressed as a percentage, and ranges from zero to 100%.
One characteristic of the RSI is that it moves slower when it reaches increased overbought or oversold conditions, and then snaps back very quickly when the market enters even a mild correction. This brings the RSI back to more neutral levels and indicates that the price trend may be able to resume.
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. 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.
A ceiling of sorts believed by technical analysts to hang over a stock — or the entire stock market — at some given level, perhaps as the result of purchases made before a decline. The thinking is that investors, waiting for a rebound, will get out when things have recovered enough to wipe out their losses. Thus, the stock or market is prevented from moving higher. The trading range between the support level and resistance level is known as a “”channel.””
A shift in the direction of the prevailing trend caused by a change in demand and/or supply. Generally the longer the reversal pattern takes to develop, the more pronounced its subsequent implications.
Simple Moving Average (SMA)
Calculated by summing the closing prices for a period of time and then dividing this total by the number of time periods. Also called an arithmetic moving average, the SMA is the average stock price over a given time period.
Stochastic Oscillator (SO)
The Stochastic Oscillator was introduced by George C. Lane. The indicator provides information about the location of a current close in relation to the period’s high and low. The closer the close is to the period’s high, the higher is the buying pressure, and the closer the close is to the period’s low, the more selling pressure is.
The indicator is considered bullish, when above 80, and bearish, when below 20. As this definition does not provide any insights on when to buy or sell, consider generating signals when the indicator moves from the overbought / oversold territory back.
The crossings between the %K and its moving average can be used for the same purpose.
Finally, the divergence can be considered a very strong signal. When the divergence develops when the indicator is moving from the overbought / oversold levels, it is a sell / buy signal.
Additionally, the K39 (unsmoothed 39 period stochastic oscillator) was reported to generate good results when tested on paper. A buy signal is generated when K crosses above 50% and the close price is above the previous week’s highest close. Sell signals are generated when K crosses below 50% and the close is below the previous week’s lowest close.
An additional confirmation can be provided by some indicators from the different group, for example, the On Balance Volume (OBV) indicator.
The most value of a stochastics is when the strong trend is present. According to Lane, the safest way to trade is to buy when the trend is up, and to sell with the downtrend.
A level below which (the thinking goes) a stock will not fall. It’s the price at which investors seem to come forward to buy, perhaps because it’s as low as the stock seems to go, or because the apparent bargain becomes irresistible. The trading range between the support level and resistance level is known as a “”channel.””
Scientific Wild-Ass Guess, or SWAG, is American slang meaning a rough estimate made by an expert in the field, based on experience and intuition. It is similar to the slang word guesstimate.
Swing Index (SI)
The Swing Index was developed to provide a line “which cuts through the maze of high, low and close prices and indicates the real strength and direction of the market.” The Swing Index is used primarily as a basis for Wilder’s Accumulative Swing Index (ASI) indicator.
Mr. Wilder summarizes the significance of the Swing Index as follows:
– Swing Index gives one numerical value that always falls between +100 and -100, while incorporating current and previous opening and closing prices and true range in its complex calculation.
– Swing Index provides a line which gives definitive short-term swing points.
The Swing Index alone doesn’t provide much in the way of signals. It should be used in conjunction with the Accumulative Swing Index.
The practice of trying to divine stock prices by examining trading patterns and comparing the shape of current charts to those from the past.
A cornerstone of technical analysis is Dow Theory (not to be confused with Dow Dividend Theory), which states that in a true bull or bear trend, both the Dow Jones Industrial and Dow Jones Transportation averages must be moving in the same direction. In general, Dow Theory adherents will buy when the market moves higher than a previous peak, and sell when it goes below the preceding valley.
Technical analysts use a variety of complex charting techniques, but some of the most basic involve plotting price movements in a stock over time on a fever chart. The shape of the chart is supposed to reveal something about whether the stock is headed up or down. A head and shoulders pattern, for instance, could imply a stock has topped out. Technicians look for stocks that have broken through their resistance level (on the upside). A stock that has broken through its support level (on the downside) is considered poised for further losses.
Critics deride technical analysis as only so much hocus-pocus, not far removed from tea-leaf reading. Advocates insist that the stock market clearly moves in broad patterns, and that these can be recognized by careful charting and a knowledge of history. Whether or not technical analysis has any validity, it has a good many adherents, and on that basis alone influences stock prices.
Three Percent Rule
Often used as a guideline to determine if a breakout or breakdown is valid. The price should move at least 3% above or below the respective level for the move to be regarded as valid.
A move in price characterized by a series of higher lows and higher highs (an uptrend) or lower highs and lower lows (a downtrend).
A line drawn through successive maximum price movements. These can be a series of two or more successively lower peaks as in a downtrend, or successively higher troughs in an uptrend. Trendlines can also be drawn through closing levels. The more instances of contact, the more reliable the trend.
Triple Exponentially (TRIX)
TRIX is a momentum indicator that displays the percent rate-of-change of a triple exponentially smoothed moving average of a security’s closing price. Oscillating around a zero line, TRIX is designed to filter out stock movements that are insignificant to the larger trend of the stock. The user selects a number of periods (such as 15) with which to create the moving average, and those cycles that are shorter than that period are filtered out.
The TRIX is a leading indicator and can be used to anticipate turning points in a trend through its divergence with the security price. Likewise, it is common to plot a moving average with a smaller period (such as 9) and use it as a “signal line” to anticipate where the TRIX is heading. TRIX line crossovers with its “signal line” can be used as buy/sell signals as well.
The volume in advancing stocks divided by the volume in declining stocks. Values will be greater than 1.0 when more volume is associated with stocks that are increasing in price than those declining. Values of less than 1.0 occur when greater volume is associated with stocks with falling prices.
Vertical Horizontal Filter (VHF)
Vertical Horizontal Filter (VHF) was created by Adam White to identify trending and ranging markets. VHF measures the level of trend activity, similar to ADX in the Directional Movement System. Trend indicators can then be employed in trending markets and momentum indicators in ranging markets.
Vary the number of periods in the Vertical Horizontal Filter to suit different time frames. White originally recommended 28 days but now prefers an 18-day window smoothed with a 6-day moving average.
There are three ways to interpret the VHF indicator:
– You can use the VHF values themselves to determine the degree that prices are trending. The higher the VHF, the higher the degree of trending and the more you should be using trend-following indicators.
– You can use the direction of the VHF to determine whether a trending or congestion phase is developing. A rising VHF indicates a developing trend; a falling VHF indicates that prices may be entering a congestion phase.
– You can use the VHF as a contrarian indicator. Expect congestion periods to follow high VHF values; expect prices to trend following low VHF values.
Volatility Ratio (VR)
This ratio is derived from the Volatility Ratio introduced by Jack Schwager in Technical Analysis to identify wide-ranging days. Wide ranging days are signaled by a Volatility Ratio greater than 2.0.
Designed to highlight breakouts from a trading range, this VR compared to true range for the indicator period.
Vomiting Camel Pattern (VCP)
A longer term technical pattern composed of a low and higher low and a high and lower high formation. It begins with a low in the market at Point (A) before moving up to a high Point (B). The market then declines from Point B to form a new pivot low Point (C), which is higher than the previous low Point (A). The market moves higher from Point (C) to form a new pivot high at Point (D), which is lower than the previous high Point (B). Summary: A is less than C and B is greater than D. Once the pivot high at Point (D) forms the camel formation vomits the market to the downside.
Zig Zag (ZIG)
The Zig Zag feature is not an indicator per se, but rather a means to filter out random noise and compare relative price movements. The Zig Zag can be set to acknowledge minimum price changes and ignore those that do not fit the criteria. The minimum price movements are set in percentage terms and can be based on either the close or high/low range.
A Zig Zag set at 10% with OHCL bars would yield a line that only reverses after a change from high to low of 10% or greater. All movements less than 10% would be ignored. If a stock traded from a low of 100 to a high of 109, the Zig Zag would not draw a line because the move was less than 10%. If the stock advanced from a low of 100 to a high of 110, then the Zig Zag would draw a line from 100 to 110. If the stock continued on to a high of 112, this line would be extended to 112 (100 to 112). The Zig Zag would not reverse until the stock declined 10% or more from its high. From a high of 112, a stock would have to decline 11.2 points (or to a low of 100.8) for the ZigZag to reverse and display another line.
The Zig Zag has zero predictive power and draws lines based on hindsight.