Technical Analysis 101
Introduction to Technical Analysis
Technical analysis is research of market dynamics that is done mainly with the help of
charts and with the purpose of forecasting future price development. Technical analysis
comprises several approaches to the study of price movement which are interconnected in
the framework of one harmonious theory. This type of analysis studies the price movement
on the market by means of analyzing three market factors: price, volumes, and, in case of
study of futures contracts’ market, of an open interest (number of open positions). Of
these three factors the primary one for technical analysis is the prices, while the alterations
in other factors are studies mainly in order to confirm the correctness of the identified price
trend. This technical theory, just like any theory, has its core postulates.
Technical analysts base their research on the following three axioms:
-
Market movement considers everything
This is the most important postulate of technical analysis. It is crucial to understand it
in order to grasp rightly the procedures of analysis. The gist of it is that any factor that
influences the price of securities, whether economic, political, or psychological, has
already been taken into account and reflected in the price chart. In other words, every
price change is accompanied by a change in external factors. The main inference of this
premise is the necessity to follow closely the price movements and analyze them. By means
of analyzing price charts and multiple other indicators, a technical analyst comes to the
point that the market itself shows to her/him the trend it will most likely follow.
This premise is in conflict with fundamental analysis where the attention is primarily paid to
the study of factors, and later on, after the analysis of the factors, to conclusions as to the
market trends are made. Thus, if the demand is higher than the supply, a fundamental analyst
will come to the conclusion that the price will grow. Technical analyst, however, makes her/his
conclusions in the opposite sequence: since the price has grown, it means the demand is higher
than the supply.
-
The prices move with the trend
This assumption is the basis for all methods of technical analysis, as a market that moves in
accordance with trends can be analyzed, unlike a chaotic market. The postulate that the price
movement is a result of a trend has two effects. The first one implies that the current trend
will most likely continue and will not reverse itself, thus, excluding disorderly chaotic
movement of the market. The second one implies that the current trend will go on until the
opposite trend sets in.
-
The history repeats itself
Technical analysis and studies of market dynamics are closely related to the studies of human
psychology. Thus, the graphical price models identified and classified within the last hundred
years depict core characteristics of the psychological state of the market. First of all,
they show the moods currently prevailing in the market, whether bullish or bearish.
Since these models worked in the past, we have reasons to suppose that they will work in the future,
for they are based on human psychology which remains almost unchaged over years. We can reword the
last postulate — the story repeats itself — in a slightly different way: the key to understanding
the future lies in the studies of the past.
Support and Resistance
Think of prices for financial instruments as a result
of a head-to-head battle between a bull (the buyer) and a
bear (the seller). Bulls push prices higher, and bears
lower them. The direction prices actually move
shows who wins the battle.
Support is a level at which bulls (i.e., buyers)
take control over the prices and prevent them
from falling lower.
Resistance, on the other hand, is the point at which
sellers (i.e., bears) take control of prices and prevent them from
rising higher. The price at which a trade takes place is the
price at which a bull and bear agree to do business. It
represents the consensus of their expectations.
Support levels indicate the price where the most of
investors believe that prices will move higher. Resistance
levels indicate the price at which the most of investors
feel prices will move lower.
But investor expectations change with the time, and they often
do so abruptly. The development of support and resistance
levels is probably the most noticeable and reoccurring event
on price charts. The breaking through support/resistance levels
can be triggered by fundamental changes that are above or below
investor's expectations (e.g., changes in earnings, management,
competition, etc.) or by self-fulfilling prophecy (investors
buy as they see prices rise). The cause is not so significant
as the effect: new expectations lead to new price levels.
There are support/resistance levels, which are more emotional.
Supply and demand
There is nothing mysterious about support and resistance:
it is classic supply and demand. Remembering ’Econ 101’
class, supply/demand lines show what the supply and
demand will be at a given price.
The supply line shows the quantity (i.e., the number of shares) that
sellers are willing to supply at a given price. When prices increase,
the quantity of sellers also increases as more investors are willing to
sell at these higher prices. The demand line shows the number of shares
that buyers are willing to buy at a given price. When prices increase,
the quantity of buyers decreases as fewer investors are willing to buy
at higher prices.
At any given price, a supply/demand chart shows how many buyers and
sellers there are. In a free market, these lines are continually changing.
Investor's expectations change, and so do the prices buyers and sellers
feel are acceptable. A breakout above a resistance level is evidence
of an upward shift in the demand line as more buyers become willing to
buy at higher prices. Similarly, the failure of a support level shows
that the supply line has shifted downward.
The foundation of most technical analysis tools is rooted in the
concept of supply and demand. Charts of prices for financial instruments
give us a superb view of these forces in action.
Traders’ remorse
After a support/resistance level has been broken through,
it is common for traders to ask temselves about to what extent new prices represent the facts.
For example, after a breakout above a resistance level, buyers
and sellers may both question the validity of the new price and
may decide to sell. This creates a phenomenon that is referred to as
"traders’ remorse": prices return to a support/resistance
level following a price breakout.
The price action following this remorseful period is crucial.
One of two things can happen: either the consensus of expectations
will be that the new price is not warranted, in which case prices
will move back to their previous level; or investors will accept the
new price, in which case prices will continue to move in the direction
of the breaking through.
In case number one, following traders’ remorse, the consensus of
expectations is that a new higher price is not warranted, a classic
"bull trap" (or false breakout) is created. For example,
the prices broke through a certain resistance level (luring in a herd
of bulls who expected prices to move higher), and then prices
dropped back to below the resistance level leaving the bulls holding
overpriced stock. Similar sentiment creates a bear trap. Prices drop below
a support level long enough to get the bears to sell (or sell short)
and then bounce back above the support level leaving the bears out of
the market.
The other thing that can happen following traders’
remorse is that investors expectations may change causing the new price
to be accepted. In this case, prices will continue to move in the
direction of the penetration.
A good way to quantify expectations following a breakout is with the
volume associated with the price breakout. If prices break through the
support/resistance level with a large increase in volume and the traders’
remorse period is on relatively low volume, it implies that the new
expectations will rule (a minority of investors are remorseful).
Conversely, if the breakout is on moderate volume and the "remorseful"
period is on increased volume, it implies that very few investor expectations
have changed and a return to the original expectations
(i.e., original prices) is warranted.
Resistance becomes support
When a resistance level is successfully broken through, that level
becomes a support level. Similarly, when a support level is
successfully broken through, that level becomes a resistance level.
The reason for it is that a new "generation" of bulls appears,
who refused to buy when prices were low. Now they are anxious to buy at any time
the prices return to the previous level. Similarly, when prices drop below a
support level, that level often becomes a resistance level that prices have a
difficult time breaking through. When prices approach the previous support level,
investors seek to limit their losses by selling.
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Accelerator / Decelerator Oscillator
Acceleration/Deceleration Technical Indicator (AC) measures
acceleration and deceleration of the current driving force.
This indicator will change direction before any changes in the driving force,
which, it its turn, will change its direction before the price. If you realize
that Acceleration/Deceleration is a signal of an earlier warning, it gives you evident advantages.
The nought line is basically the spot where the driving force is at
balance with the acceleration. If Acceleration/Deceleration is higher than nought, then it is
usually easier for the acceleration to continue the upward movement (and
vice versa in cases when it is below nought). Unlike in case with Awesome Oscillator, it
is not regarded as a signal when the nought line is crossed. The only
thing that needs to be done to control the market and make decisions is
to watch for changes in color. To save yourself serious reflections, you
must remember: you can not buy with the help of Acceleration/Deceleration,
when the current column is colored red, and you can not sell, when the
current column is colored green.
If you enter the market in the direction of the driving force
(the indicator is higher than nought, when buying, or it is lower than
nought, when selling), then you need only two green columns to buy (two
red columns to sell). If the driving force is directed against the position
to be opened (indicator below nought for buying, or higher than nought for
selling), a confirmation is needed, hence, an additional column is required.
In this case the indicator is to show three red columns over the nought line
for a short position and three green columns below the nought line for a
long position.
Calculation
AC bar chart is the difference between the value of 5/34 of the driving
force bar chart and 5-period simple moving average, taken from that bar chart.
AO = SMA(median price, 5)-SMA(median price, 34)
AC = AO-SMA(AO, 5)
Where:
SMA — Simple Moving Average;
AO — Awesome Oscillator.
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Accumulation / Distribution
Accumulation/Distribution Technical Indicator is determined by the
changes in price and volume. The volume acts as a weighting
coefficient at the change of price — the higher the coefficient
(the volume) is, the greater the contribution of the price
change (for this period of time) will be in the value of the
indicator
In fact, this indicator is a variant of the more commonly
used indicator On Balance Volume.
They are both used to confirm price changes by means of measuring
the respective volume of sales.
When the Accumulation/Distribution indicator grows, it means
accumulation (buying) of a particular security, as the overwhelming
share of the sales volume is related to an upward trend of prices.
When the indicator drops, it means distribution (selling) of the
security, as most of sales take place during the downward price
movement.
Divergences between the Accumulation/Distribution indicator and the price of the
security indicate the upcoming change of prices. As a rule, in
case of such divergences, the price tendency moves in the direction
in which the indicator moves. Thus, if the indicator is growing, and
the price of the security is dropping, a turnaround of price should
be expected.
Calculation:
A certain share of the daily volume is added to or subtracted
from the current accumulated value of the indicator. The nearer the
closing price to the maximum price of the day is, the higher the
added share will be. The nearer the closing price to the minimum price
of the day is, the greater the subtracted share will be. If the closing
price is exactly in between the maximum and minimum of the day, the indicator
value remains unchanged.
A/D = SUM[((CLOSE — MINIMUM) — (MAXIMUM — CLOSE))*VOLUME/(MAXIMUM — MINIMUM), N]
Where:
N — the quantity of periods used in the calculation.
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Alligator
"Most of the time the market remains stationary. Only for some 15–30% of
time the market generates trends, and traders who are not located in the
exchange itself derive most of their profits from the trends. My Grandfather
used to repeat: "Even a blind chicken will find its corns, if it is always fed
at the same time". We call the trade on the trend "a blind chicken market".
It took us years, but we have produced an indicator, that lets us always keep
our powder dry until we reach the blind chicken market"
Bill Williams
In principle, Alligator Technical Indicator is a combination
of Balance Lines (Moving Averages) that
use fractal geometry and nonlinear dynamics.
The blue line (Alligator’s Jaw) is
the Balance Line for the timeframe that was used to build the chart
(13-period
Smoothed Moving Average,
moved into the future by 8 bars);
The red line (Alligator’s Teeth) is
the Balance Line for the value timeframe of one level lower
(8-period
Smoothed Moving Average,
moved by 5 bars into the future);
The green line (Alligator’s Lips)
is the Balance Line for the value timeframe, one more level lower (5-period
Smoothed Moving Average,
moved by 3 bars into the future).
Lips, Teeth and Jaw of the Alligator show the interaction of different time
periods. As clear trends can be seen only
15 to 30 per cent of the time, it is essential to follow them and refrain
from working on markets that fluctuate only within certain price periods.
When the Jaw, the Teeth and the Lips are closed or intertwined, it means
the Alligator is going to sleep or is asleep already. As it sleeps, it
gets hungrier and hungrier — the longer it will sleep, the hungrier it
will wake up. The first thing it does after it wakes up is to open its
mouth and yawn. Then the smell of food comes to its nostrils: flesh of
a bull or flesh of a bear, and the Alligator starts to hunt it. Having
eaten enough to feel quite full, the Alligator starts to lose the interest
to the food/price (Balance Lines join together) — this is the time
to fix the profit.
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Average Directional Movement Index - ADX
Average Directional Movement Index Technical Indicator (ADX)
helps to determine if there is a price
trend. It was developed and
described in detail by Welles Wilder in his book "New concepts in
technical trading systems".
The simplest trading method based on the system of directional movement
implies comparison of two direction indicators:
the 14-period +DI one and the 14-period -DI. To do
this, one either puts the charts of indicators one on top
of the other, or +DI is subtracted from -DI. W. Wilder recommends
buying when +DI is higher than -DI, and selling when +DI sinks lower than -DI.
To these simple commercial rules Wells Wilder added "a rule of points
of extremum". It is used to eliminate false signals and decrease the
number of deals. According to the principle of points of extremum, the
"point of extremum" is the point when +DI and -DI cross each
other. If +DI raises higher than -DI, this point will be the maximum price
of the day when they cross. If +DI is lower than -DI, this point will be
the minimum price of the day they cross.
The point of extremum is used then as the market entry level. Thus,
after the signal to buy (+DI is higher than -DI) one must wait till the
price has exceeded the point of extremum, and only then buy. However, if
the price fails to exceed the level of the point of extremum, one should
retain the short position.
Calculation
ADX = SUM[(+DI-(-DI))/(+DI+(-DI)), N]/N
Where:
N — the number of periods used in the calculation.
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Average True Range - ATR
Average True Range Technical Indicator (ATR) is an indicator that shows volatility of the market.
It was introduced by Welles Wilder in his book "New concepts in technical trading systems".
This indicator has been used as a component of numerous other indicators and trading systems ever since.
Average True Range can often reach a high value at the bottom of the
market after a sheer fall in prices occasioned by panic selling. Low values of
the indicator are typical for the periods of sideways movement of long
duration which happen at the top of the market and during consolidation.
Average True Range can be interpreted according
to the same principles as other volatility indicators. The principle of forecasting based on this indicator
can be worded the following way: the higher the value of the indicator, the higher the probability of a trend
change; the lower the indicator’s value, the weaker the trend’s movement is.
Calculation
True Range is the greatest of the following three values:
- Difference between the current maximum and minimum (high and low);
- Difference between the previous closing price and the current maximum;
- Difference between the previous closing price and the current minimum.
The indicator of Average True Range is a moving average of values of the true range.
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Awesome Oscillator
Awesome Oscillator Technical Indicator (AO) is a 34-period simple moving average,
plotted through the middle points of the bars (H+L)/2, which is
subtracted from the 5-period simple moving average, built across the
central points of the bars (H+L)/2. It shows us quite clearly
what’s happening
to the market driving force at the present moment.
Signals to buy
Saucer
This is the only signal to buy that comes when the bar chart
is higher than the nought line. One must bear in mind:
- the saucer signal is generated when the bar chart reversed its
direction from the downward to upward. The second column is lower than
the first one and is colored red. The third column is higher than
the second and is colored green.
- for the saucer signal to be generated the bar chart should
have at least three columns.
- Keep in mind, that all Awesome Oscillator columns should be over the nought line
for the saucer signal to be used.
Nought line crossing
The signal to buy is generated when the bar chart passes from the
area of negative values to that of positive. It comes when the bar
chart crosses the nought line. As regards this signal:
for this signal to be generated, only two columns are necessary;
- the first column is to be below the nought line, the second one is
to cross it (transition from a negative value to a positive one)
- simultaneous generation of signals to buy and to sell is impossible.
Two pikes
This is the only signal to buy that can be generated when the bar chart
values are below the nought line. As regards this signal,
please, bear in mind:
- the signal is generated, when you have a pike pointing down
(the lowest minimum) which is below the nought line and is followed
by another down-pointing
pike which is somewhat higher (a negative figure with a lesser
absolute value, which is therefore closer to the nought line), than the previous down-looking pike.
- the bar chart is to be below the nought line between the two
pikes. If the bar chart crosses the nought line in the section
between the pikes, the signal to buy doesn’t function. However, a
different signal to buy will be generated — nought line crossing.
- each new pike of the bar chart is to be higher (a negative number of a lesser
absolute value that is closer to the nought line) than the previous pike.
- if an additional higher pike is formed (that is closer to the nought line) and the bar
chart has not crossed the nought line, an additional signal to buy will be generated.
Signals to sell
Awesome Oscillator signals to sell are identical to the signals to buy. The saucer signal is
reversed and is below zero. Nought line crossing is on the decrease — the first
column of it is over the nought, the second one is under it. The two pikes signal
is higher than the nought line and is reversed too.
Calculation
AO is a 34-period simple moving average, plotted through the central
points of the bars (H+L)/2, and subtracted from the 5-period simple moving
average, graphed across the central points of the bars (H+L)/2.
MEDIAN PRICE = (HIGH+LOW)/2
AO = SMA(MEDIAN PRICE, 5)-SMA(MEDIAN PRICE, 34)
Where:
SMA — Simple Moving Average.
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Bollinger Bands
Bollinger Bands Technical Indicator (BB) is similar to
Envelopes.
The only difference is that the bands of Envelopes are plotted a
fixed distance (%) away from the
moving average, while the Bollinger
Bands are plotted a certain number of standard deviations away from it.
Standard deviation is a measure of volatility, therefore Bollinger Bands
adjust themselves to the market conditions. When the markets become more
volatile, the bands widen and they contract during less volatile periods.
Bollinger Bands are usually plotted on the price chart, but they
can be also added to the indicator chart (Custom Indicators). Just
like in case of the Envelopes,
the interpretation of the Bollinger Bands is based on the fact that the
prices tend to remain in between the top and the bottom line of the bands.
A distinctive feature of the Bollinger Band indicator is its variable width
due to the volatility of prices.
In periods of considerable price changes (i.e. of high volatility)
the bands widen leaving a lot of room to the prices to move in. During
standstill periods, or the periods of low volatility the band contracts
keeping the prices within their limits.
The following traits are particular to the Bollinger Band:
- abrupt changes in prices tend to happen after the band
has contracted due to decrease of volatility.
- if prices break through the upper band, a continuation
of the current trend is to be expected.
- if the pikes and hollows outside the band are followed by
pikes and hollows inside the band, a reverse of trend may occur.
- the price movement that has started from one of the band’s
lines usually reaches the opposite one. The last observation is useful
for forecasting price guideposts.
Calculation
Bollinger bands are formed by three lines. The
middle line (ML) is a usual Moving Average.
ML = SUM [CLOSE, N]/N
The top line, TL, is the same as the middle line a
certain number of standard deviations (D) higher than the ML.
TL = ML + (D*StdDev)
The bottom line (BL) is the middle line shifted down by
the same number of standard deviations.
BL = ML — (D*StdDev)
Where:
N — is the number of periods used in calculation;
SMA — Simple Moving Average;
StdDev — means Standard Deviation.
StdDev = SQRT(SUM[(CLOSE — SMA(CLOSE, N))^2, N]/N)
It is recommended to use 20-period
Simple Moving Average as the middle line, and plot top and bottom lines two standard deviations away from it. Besides,
moving averages of less than 10 periods are of little effect.
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Commodity Channel Index - CCI
Commodity Channel Index Technical Indicator (CCI)
measures the deviation of the
commodity price from its average statistical price. High values
of the index point out that the price is unusually high being
compared with the average one, and low values show that the price
is too low. In spite of its name, the Commodity Channel Index can be applied for any
financial instrument, and not only for the wares.
There are two basic techniques of using Commodity Channel Index:
Finding the divergences
The divergence appears when the price reaches a new maximum, and
Commodity Channel Index can not grow above the previous maximums. This classical
divergence is normally followed by the price correction.
As an indicator of overbuying/overselling
Commodity Channel Index usually varies in the range of ±100. Values above +100 inform
about overbuying state (and about a probability of correcting decay),
and the values below 100 inform about the overselling state (and about
a probability of correcting increase).
Calculation
To find a Typical Price. You need to add the HIGH, the LOW,
and the CLOSE prices of each bar and then divide the result by 3.
TP = (HIGH + LOW +CLOSE)/3
To calculate the n-period Simple Moving Average of typical prices.
SMA(TP, N) = SUM[TP, N]/N
To subtract the received SMA(TP, N) from Typical Prices.
D = TP — SMA(TP, N)
To calculate the n-period Simple Moving Average of absolute D values.
SMA(D, N) = SUM[D, N]/N
To multiply the received SMA(D, N) by 0,015.
M = SMA(D, N) * 0,015
To divide M by D
CCI = M/D
Where:
SMA — Simple Moving Average;
N — number of periods, used for calculation.
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DeMarker
Demarker Technical Indicator is based on the comparison of the period
maximum with the previous period maximum. If the current period (bar)
maximum is higher, the respective difference between the two will be registered.
If the current maximum is lower or equaling the maximum of the previous period, the
naught value will be registered. The differences received for N periods are then
summarized. The received value is used as the numerator of the DeMarker and will be
divided by the same value plus the sum of differences between the price minima of the
previous and the current periods (bars). If the current price minimum is greater than
that of the previous bar, the naught value will be registered.
When the indicator falls below 30, the bullish price reversal should be expected.
When the indicator rises above 70, the bearish price reversal should be expected.
If you use periods of longer duration, when calculating the indicator, you’ll be
able to catch the long term market tendency. Indicators based on short periods let
you enter the market at the point of the least risk and plan the time of transaction
so that it falls in with the major trend.
Calculation:
The value of the DeMarker for the "i" interval is calculated as follows:
The DeMax(i) is calculated:
If high(i) > high(i-1) , then DeMax(i) = high(i)-high(i-1), otherwise DeMax(i) = 0
The DeMin(i) is calculated:
If low(i) < low(i-1), then DeMin(i) = low(i-1)-low(i), otherwise DeMin(i) = 0
The value of the DeMarker is calculated as:
DMark(i) = SMA(DeMax, N)/(SMA(DeMax, N)+SMA(DeMin, N))
Where:
SMA — Simple Moving Average;
N — the number of periods used in the calculation.
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Elder-rays
Elder-Rays Technical Indicator combine the properties of
trend following indicators
and oscillators. They use
Exponential Moving Average
indicator (EMA, the best period is 13) as a tracing indicator. The oscillators
reflect the power of bulls and bears.To plot the Elder-Rays three charts should
be used: on one side, the price chart and
Exponential Moving Average
will be plotted, on two other sides bulls power oscillator (Bulls Power) and bears power
oscillator (Bears Power) will be plotted.
Elder-rays are used both individually and together with other methods.
If using them individually, one should take into account that the
Exponential Moving Average
slope determines the trend movement, and position should be opened in its
direction. Bulls and bears power oscillators are applied for defining the
moment of positions opening/closing.
Buy if:
- there is an increasing trend (determined with the Exponential Moving Average movement);
- the Bears Power oscillator is negative, but increasing at the same time;
- the last peak of the Bulls Power oscillator is higher than the previous one;
- the Bears Power oscillator increases after the Bulls divergence.
At the positive values of the Bears Power oscillator, it is better to keep back.
Sell if:
- there is a decreasing trend (determined with the Exponential Moving Average movement);
- the Bulls Power oscillator is positive, but decreases gradually;
- the last trough of the Bulls Power oscillator is lower than the previous one;
- the Bulls Power oscillator decreases leaving the Bears’ divergence.
Do not open short positions when the Bulls Power oscillator is negative.
Divergence between the Bulls and Bears Power and prices is the best time for trading.
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Envelopes
Envelopes Technical Indicator is formed with two
Moving Averages one of which is
shifted upward and another one is shifted downward. The selection of
optimum relative number of band margins shifting is determined with
the market volatility: the higher the latter is, the stronger the
shift is.
Envelopes define the upper and the lower margins of the price range.
Signal to sell appears when the price reaches the upper margin of the band;
signal to buy appears when the price reaches the lower margin.
The logic behind envelopes is that overzealous buyers and sellers push the
price to the extremes (i.e., the upper and lower bands), at which point
the prices often stabilize by moving to more realistic levels. This is
similar to the interpretation of Bollinger Bands.
Calculation
Upper Band = SMA(CLOSE, N)*[1+K/1000]
Lower Band = SMA(CLOSE, N)*[1-K/1000]
Where:
SMA — Simple Moving Average;
N — averaging period;
K/1000 — the value of shifting from the average (measured in basis points).
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Force Index
Force Index Technical Indicator was developed by Alexander Elder. This index measures
the Bulls Power at each increase, and the Bulls Power at each decrease.
It connects the basic elements of market information: price trend, its drops,
and volumes of transactions. This index can be used as it is, but it is
better to approximate it with the help of
Moving Average. Approximation
with the help a short moving average (the author proposes to use 2
intervals) contributes to finding the best opportunity to open and
close positions. If the approximations is made with long moving
average (period 13), the index shows the trends
and their changes.
- It is better to buy when the forces become minus (fall below zero) in the period of indicator increasing tendency;
- The force index signalizes the continuation of the increasing tendency when it increases to the new peak;
- The signal to sell comes when the index becomes positive during the decreasing tendency;
- The force index signalizes the Bears Power and continuation of the decreasing tendency when the index falls to the new trough;
- If price changes do not correlate to the corresponding changes in volume, the force indicator stays on one level, which tells you the trend is going to change soon.
Calculation
The force of every market movement is characterized by its direction, scale and volume.
If the closing price of the current bar is higher than the preceding bar, the force is positive.
If the current closing price if lower than the preceding one, the force is negative. The greater
the difference in prices is, the greater the force is. The greater the transaction volume is,
the greater the force is.
FORCE INDEX (i) = VOLUME (i) * ((MA (ApPRICE, N, i) - MA (ApPRICE, N, i-1))
Where:
FORCE INDEX (i) — Force Index of the current bar;
VOLUME (i) — volume of the current bar;
MA (ApPRICE, N, i) — any Moving Average of the current bar for N period:
Simple, Exponential, Weighted or Smoothed;
ApPRICE — applied price;
N — period of the smoothing;
MA (ApPRICE, N, i-1) — any Moving Average of the previous bar.
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Fractals
All markets are characterized by the fact that on the
most part the prices do not change too much, and only
short periods of time (15–30 percent) account for trend
changes. Most lucrative periods are usually the case
when market prices change according to a certain trend.
A Fractal is one of five indicators of Bill Williams’
trading system, which allows to detect the bottom or the top.
Fractal Technical Indicator it is a series of at least five successive bars, with the
highest HIGH in the middle, and two lower HIGHs on both sides.
The reversing set is a series of at least five successive bars,
with the lowest LOW in the middle, and two higher LOWs on both
sides, which correlates to the sell fractal. The fractals are
have High and Low values and are indicated with the up and
down arrows.
The fractal needs to be filtrated with the use of
Alligator. In other words,
you should not close a buy transaction, if the fractal is
lower than the Alligator’s Teeth, and you should not close a
sell transaction, if the fractal is higher than the
Alligator’s Teeth. After the fractal signal has been
created and is in force, which is determined by its position
beyond the Alligator’s Mouth, it remains a signal until
it gets attacked, or until a more recent fractal signal emerges.
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Gator Oscillator
Gator Oscillator is based on the Alligator
and shows the degree of convergence/divergence of the Balance Lines
(Smoothed Moving Averages). The
top bar chart is the absolute difference between the values of the blue
and the red lines. The bottom bar chart is the absolute difference between
the values of the red line and the green line, but with the minus sign, as
the bar chart is drawn top-down.
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Ichimoku Kinko Hyo
Ichimoku Kinko Hyo Technical Indicator is predefined to characterize the
market
Trend,
Support and Resistance Levels, and to generate
signals of buying and selling. This indicator works best at
weekly and daily charts.
When defining the dimension of parameters, four time
intervals of different length are used. The values of individual
lines composing this indicator are based on these intervals:
Tenkan-sen shows the average price value during the first time
interval defined as the sum of maximum and minimum within this time, divided by two;
Kijun-sen shows the average price value during the second time interval;
Senkou Span A shows the middle of the distance between
two previous lines shifted forwards by the value of the
second time interval;
Senkou Span B shows the average price value during the
third time interval shifted forwards by the value of the
second time interval.
Chinkou Span shows the closing price of the current candle
shifted backwards by the value of the second time interval.
The distance between the Senkou lines is hatched with another
color and called "cloud". If the price is between these lines,
the market should be considered as non-trend, and then the
cloud margins form the support and resistance levels.
If the price is above the cloud, its upper line forms
the first support level, and the second line forms
the second support level;
If the price is below cloud, the lower line forms
the first resistance level, and the upper one forms
the second level;
If the Chinkou Span line traverses the price chart in the
bottom-up direction it is signal to buy. If the Chinkou
Span line traverses the price chart in the top-down
direction it is signal to sell.
Kijun-sen is used as an indicator of the market movement.
If the price is higher than this indicator, the prices will
probably continue to increase. When the price traverses this
line the further trend changing is possible.
Another kind of using the Kijun-sen is giving signals.
Signal to buy is generated when the Tenkan-sen line traverses
the Kijun-sen in the bottom-up direction. Top-down direction
is the signal to sell.
Tenkan-sen is used as an indicator of the market trend.
If this line increases or decreases, the trend exists. When
it goes horizontally, it means that the market has come into
the channel.
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Market Facilitation Index - BW MFI
Market Facilitation Index Technical Indicator (BW MFI) is the indicator
which shows the change of price for one tick. Absolute values of the
indicator do not mean anything as they are, only indicator changes have sense.
Bill Williams emphasizes the interchanging of MFI and volume:
Market Facilitation Index increases and volume increases — this points out that: a) the number of players
coming into the market increases (volume increases) b) the new coming
players open positions in the direction of bar development, i.e., the movement
has begun and picks up speed;
Market Facilitation Index falls and volume falls. It means the market participants are not interested anymore;
Market Facilitation Index increases, but the volume falls. It is most likely, that the market is not supported
with the volume from clients, and the price is changing due to traders’
(brokers and dealers) "on the floor" speculations;
Market Facilitation Index falls, but the volume increases. There is a battle between bulls and bears,
characterized by a large sell and buy volume, but the price is not changing significantly
since the forces are equal. One of the contending parties (buyers vs. sellers) will
eventually win the battle. Usually, the break of such a bar lets you know if this
bar determines the continuation of the trend or annuls the
trend. Bill Williams
calls such bar "curtsying".
Calculation:
To calculate Market Facilitation Index you need to subtract the lowest bar price from the highest
bar price and divide it by the volume.
BW MFI = RANGE*(HIGH-LOW)/VOLUME
Where:
RANGE — is the multiplication factor, which brings the difference in points down to whole numbers.
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Momentum
The Momentum Technical Indicator measures the amount that a
security’s price has changed over a given time span.
There are basically two ways to use the Momentum indicator:
You can use the Momentum indicator as a trend-following oscillator
similar to the Moving Average Convergence/Divergence (MACD).
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
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.
Calculation
Momentum is calculated as a ratio of today’s price to the price several (N) periods ago.
MOMENTUM = CLOSE(i)/CLOSE(i-N)*100
Where:
CLOSE(i) — is the closing price of the current bar;
CLOSE(i-N) — is the closing bar price N periods ago.
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Money Flow Index - MFI
Money Flow Index (MFI) is the technical indicator, which indicates the
rate at which money is invested into a security and then withdrawn
from it. Construction and interpretation of the indicator is
similar to Relative Strenght Index with the only difference that
volume is important to MFI.
When analyzing the money flow index one needs to take into consideration the following points:
- divergences between the indicator and price movement. If prices grow while MFI falls
(or vice versa), there is a great probability of a price turn;
- Money Flow Index value, which is over 80 or under 20, signals correspondingly of
a potential peak or bottom of the market.
Calculation
The calculation of Money Flow Index includes several stages. At first one defines the typical price
(TP) of the period in question.
TP = (HIGH + LOW + CLOSE)/3
Then one calculates the amount of the Money Flow (MF):
MF = TP * VOLUME
If today’s typical price is larger than yesterday’s TP, then the money flow is considered positive.
If today’s typical price is lower than that of yesterday, the money flow is considered negative.
A positive money flow is a sum of positive money flows for a selected period of time.
A negative money flow is the sum of negative money flows for a selected period of time.
Then one calculates the money ratio (MR) by dividing the positive money flow by the negative money flow:
MR = Positive Money Flow (PMF)/Negative Money Flow (NMF)
And finally, one calculates the money flow index using the money ratio:
MFI = 100 - (100 / (1 + MR))
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Moving Averages
The Moving Average Technical Indicator shows the mean instrument price value for a
certain period of time. When one calculates the moving average, one
averages out the instrument price for this time period. As the price
changes, its moving average either increases, or decreases.
There are four different types of moving averages:
Simple (also referred to as Arithmetic),
Exponential,
Smoothed and
Linear Weighted.
Moving averages may be calculated for any sequential data set, including
opening and closing prices, highest and lowest prices, trading volume or
any other indicators. It is often the case when double moving averages
are used.
The only thing where moving averages of different types diverge
considerably from each other, is when weight coefficients, which are
assigned to the latest data, are different. In case we are talking of
simple moving average, all prices of the time period in question, are
equal in value. Exponential and
Linear Weighted Moving Averages attach more
value to the latest prices.
The most common way to interpreting the price moving average is to
compare its dynamics to the price action. When the instrument price
rises above its moving average, a buy signal appears, if the
price falls below its moving average, what we have is a sell
signal.
This trading system, which is based on the moving average, is not designed
to provide entrance into the market right in its lowest point, and its exit
right on the peak. It allows to act according to the following trend: to buy
soon after the prices reach the bottom, and to sell soon after the prices have
reached their peak.
Moving averages may also be applied to indicators. That is where the interpretation
of indicator moving averages is similar to the interpretation of price moving
averages: if the indicator rises above its moving average, that means that the
ascending indicator movement is likely to continue: if the indicator falls below
its moving average, this means that it is likely to continue going downward.
Here are the types of moving averages on the chart:
Simple Moving Average (SMA)
Exponential Moving Average (EMA)
Smoothed Moving Average (SMMA)
Linear Weighted Moving Average (LWMA)
Calculation:
Simple Moving Average (SMA)
Simple, in other words, arithmetical moving average is calculated by
summing up the prices of instrument closure over a certain number of single
periods (for instance, 12 hours). This value is then divided by the number
of such periods.
SMA = SUM(CLOSE, N)/N
Where:
N — is the number of calculation periods.
Exponential Moving Average (EMA)
Exponentially smoothed moving average is calculated by adding the moving average
of a certain share of the current closing price to the previous value. With exponentially
smoothed moving averages, the latest prices are of more value. P-percent exponential
moving average will look like:
EMA = (CLOSE(i)*P)+(EMA(i-1)*(100-P))
Where:
CLOSE(i) — the price of the current period closure;
EMA(i-1) — Exponentially Moving Average of the previous period closure;
P — the percentage of using the price value.
Smoothed Moving Average (SMMA)
The first value of this smoothed moving average is calculated as the simple moving average (SMA):
SUM1 = SUM(CLOSE, N)
SMMA1 = SUM1/N
The second and succeeding moving averages are calculated according to this formula:
SMMA(i) = (SUM1-SMMA1+CLOSE(i))/N
Where:
SUM1 — is the total sum of closing prices for N periods;
SMMA1 — is the smoothed moving average of the first bar;
SMMA(i) — is the smoothed moving average of the current bar (except for the first one);
CLOSE(i) — is the current closing price;
N — is the smoothing period.
Linear Weighted Moving Average (LWMA)
In the case of weighted moving average, the latest data is of more value than more
early data. Weighted moving average is calculated by multiplying each one of the closing
prices within the considered series, by a certain weight coefficient.
LWMA = SUM(Close(i)*i, N)/SUM(i, N)
Where:
SUM(i, N) — is the total sum of weight coefficients.
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Moving Average Convergence/Divergence - MACD
Moving Average Convergence/Divergence is the next trend-following
dynamic indicator. It indicates the correlation between two price
moving averages.
The Moving Average Convergence/Divergence Technical Indicator is the
difference between a 26-period and 12-period
Exponential Moving Average (EMA).
In order to clearly show buy/sell opportunities, a so-called
signal line (9-period indicators` moving average) is plotted on the MACD chart.
The MACD proves most effective in wide-swinging trading markets.
There are three popular ways to use the Moving Average Convergence/Divergence: crossovers,
overbought/oversold conditions, and divergences.
Crossovers
The basic MACD trading rule is to sell when the MACD falls below
its signal line. Similarly, a buy signal occurs when the
Moving Average Convergence/Divergence
rises above its signal line. It is also popular to buy/sell when
the MACD goes above/below zero.
Overbought/oversold conditions
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.
Divergence
An indication that an end to the current trend may be near occurs
when the MACD diverges from the security. A bullish divergence occurs
when the Moving Average Convergence/Divergence indicator is making new highs while prices fail to reach new highs.
A bearish divergence occurs when the MACD is making new lows while prices
fail to reach new lows. Both of these divergences are most significant
when they occur at relatively overbought/oversold levels.
Calculation
The MACD is calculated by subtracting the value of a 26-period exponential moving
average from a 12-period exponential moving average. A 9-period dotted simple
moving average of the MACD (the signal line) is then plotted on top of the MACD.
MACD = EMA(CLOSE, 12)-EMA(CLOSE, 26)
SIGNAL = SMA(MACD, 9)
Where:
EMA — the Exponential Moving Average;
SMA — the Simple Moving Average;
SIGNAL — the signal line of the indicator.
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Moving Average of Oscillator
Moving Average of Oscillator is the difference between the oscillator and
oscillator smoothing. In this case, Moving Average Convergence/Divergence base-line is used as the oscillator,
and the signal line is used as the smoothing.
Calculation
OSMA = MACD-SIGNAL
Where:
MACD — the differnce of a fast EMA and a slow EMA
SIGNAL — SMA(MACD, 9)
EMA — the Exponential Moving Average;
SMA — the Simple Moving Average;
SIGNAL — the signal line of the indicator.
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On Balance Volume
On Balance Volume Technical Indicator (OBV) is a momentum technical indicator that relates
volume to price change. The indicator, which Joseph Granville
came up with, is pretty simple. When the security closes higher
than the previous close, all of the day’s volume is considered
up-volume. When the security closes lower than the previous
close, all of the day’s volume is considered down-volume.
The basic assumption, regarding On Balance Volume analysis, is that OBV
changes precede price changes. The theory is that smart money
can be seen flowing into the security by a rising OBV. When the
public then moves into the security, both the security and the
On Balance Volume will surge ahead.
If the security’s price movement precedes OBV movement, a
"non-confirmation" has occurred. Non-confirmations can occur at
bull market tops (when the security rises without, or before, the OBV) or
at bear market bottoms (when the security falls without, or before,
the On Balance Volume Technical Indicator).
The OBV is in a rising trend when each new peak is higher than the
previous peak and each new trough is higher than the previous trough.
Likewise, the On Balance Volume is in a falling
trend when each successive peak is
lower than the previous peak and each successive trough is lower than
the previous trough. When the OBV is moving sideways and is not making
successive highs and lows, it is in a doubtful trend.
Once a trend is established, it remains in force until it is broken.
There are two ways in which the On Balance Volume trend can be broken. The first occurs
when the trend changes from a rising trend to a falling trend, or from a
falling trend to a rising trend.
The second way the OBV trend can be broken is if the trend changes to a
doubtful trend and remains doubtful for more than three days. Thus, if the
security changes from a rising trend to a doubtful trend and remains doubtful
for only two days before changing back to a rising trend, the On Balance Volume is considered
to have always been in a rising trend.
When the OBV changes to a rising or falling trend, a "breakout" has occurred.
Since OBV breakouts normally precede price breakouts, investors should buy long
on On Balance Volume upside breakouts. Likewise, investors should sell short when the OBV
makes a downside breakout. Positions should be held until the trend changes.
Calculation
If today’s close is greater than yesterday’s close then:
OBV(i) = OBV(i-1)+VOLUME(i)
If today’s close is less than yesterday’s close then:
OBV(i) = OBV(i-1)-VOLUME(i)
If today’s close is equal to yesterday’s close then:
OBV(i) = OBV(i-1)
Where:
OBV(i) — is the indicator value of the current period;
OBV(i-1) — is the indicator value of the previous period;
VOLUME(i) — is the volume of the current bar.
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Parabolic SAR
Parabolic SAR Technical Indicator was developed for analyzing the
trending markets.
The indicator is constructed on the price chart. This indicator is
similar to the
Moving Average Technical Indicator
with the only difference that Parabolic SAR moves with higher
acceleration and may change its position in
terms of the price. The indicator is below the prices on the
bull market (Up Trend), when
it’s
bearish (Down Trend),
it is above the prices.
If the price crosses Parabolic SAR lines, the indicator turns, and
its further values are situated on the other side of the price. When
such an indicator turn does take place, the maximum or the minimum price
for the previous period would serve as the starting point. When the
indicator makes a turn, it gives a signal of the trend end (correction
stage or flat), or of its turn.
The Parabolic SAR is an outstanding indicator for providing exit
points. Long positions should be closed when the price sinks below the
SAR line, short positions should be closed when the price rises above the
SAR line. It is often the case that the indicator serves as a trailing
stop line.
If the long position is open (i.e., the price is above the SAR line),
the Parabolic SAR line will go up, regardless of what direction the prices take. The
length of the SAR line movement depends on the scale of the price movement.
Calculation
SAR(i) = SAR(i-1)+ACCELERATION*(EPRICE(i-1)-SAR(i-1))
Where:
SAR(i-1) — is the value of the indicator on the previous bar;
ACCELERATION — is the acceleration factor;
EPRICE(i-1) — is the highest (lowest) price for the previous period
(EPRICE=HIGH for long positions and EPRICE=LOW for short positions).
The indicator value increases if the price of the current bar is
higher than previous bullish and vice versa. The acceleration factor
(ACCELERATION) will double at the same time, which would cause
Parabolic SAR and the price to come together. In other words, the
faster the price grows or sinks, the faster the indicator
approaches the price.
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Relative Strength Index - RSI
The Relative Strenght Index Technical Indicator (RSI) is a
price-following oscillator that ranges between 0 and 100. When
Wilder introduced the Relative Strenght Index, he recommended using
a 14-day RSI.. Since then, the 9-day and
25-day Relative Strenght Index indicators have also gained
popularity.
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 Relative Strenght Index 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.
Ways to use Relative Strenght Index for chart analysis:
Tops and bottoms
The Relative Strenght Index 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 or triangles
that may or may not be visible on the price chart;
Failure swing (
Support or Resistance penetrations or breakouts)
This is where the Relative Strenght Index surpasses a previous high (peak) or falls below a recent low (trough);
Support and Resistance levels
The Relative Strenght Index 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 Relative Strenght Index. Prices usually correct and move in the direction of the RSI
Calculation
RSI = 100-(100/(1+U/D))
Where:
U — is the average number of positive price changes;
D — is the average number of negative price changes.
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Relative Vigor Index - RVI
The main point of Relative Vigor Index Technical Indicator (RVI) is that on the bull market the closing price is, as
a rule, higher, than the opening price. It is the other way round on the
bear market. So the idea behind Relative Vigor Index is that the vigor, or energy, of the
move is thus established by where the prices end up at the close. To normalize
the index to the daily trading range, divide the change of price by the maximum
range of prices for the day. To make a more smooth calculation, one uses
Simple Moving Average.
10 is the best period. To avoid probable ambiguity one needs to
construct a signal line, which is a 4-period symmetrically weighted moving average of Relative Vigor Index values. The concurrence of lines serves as a signal to buy or to sell.
Calculation
RVI = (CLOSE-OPEN)/(HIGH-LOW)
Where:
OPEN — is the opening price;
HIGH — is the maximum price;
LOW — is the minimum price;
CLOSE — is the closing price.
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Stochastic Oscillator
The Stochastic Oscillator Technical Indicator 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 instance: where prices are making a series of
new highs and the Stochastic Oscillator is failing to surpass its previous highs.
Calculation
The Stochastic Oscillator has four variables:
%K periods. This is the number of time periods used in the stochastic calculation;
%K Slowing Periods. This value controls the internal smoothing of %K. A value of
1 is considered a fast stochastic; a value of 3 is considered a slow stochastic;
%D periods. his is the number of time periods used when calculating a moving average of %K;
%D method. The method (i.e., Exponential, Simple, Smoothed, or Weighted) that is used to calculate %D.
The formula for %K is:
%K = (CLOSE-LOW(%K))/(HIGH(%K)-LOW(%K))*100
Where:
CLOSE — is today’s closing price;
LOW(%K) — is the lowest low in %K periods;
HIGH(%K) — is the highest high in %K periods.
The %D moving average is calculated according to the formula:
%D = SMA(%K, N)
Where:
N — is the smoothing period;
SMA — is the Simple Moving Average.
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Williams' Percent Range
Williams Percent Range Technical Indicator (%R) is a dynamic technical indicator, which determines whether
the market is overbought/oversold. Williams’ %R is very similar to the
Stochastic Oscillator. The only
difference is that %R has an upside down scale and the Stochastic Oscillator has internal smoothing.
To show the indicator in this upside down fashion, one places a minus symbol
before the Williams Percent Range values (for example -30%). One should ignore the minus symbol when
conducting the analysis.
Indicator values ranging between 80 and 100% indicate that the market is
oversold. Indicator values ranging between 0 and 20% indicate that the
market 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 is showing an overbought condition, it is wise to wait for the security’s
price to turn down before selling the security.
An interesting phenomenon of the Williams Percent Range 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, Williams Percent Range usually creates a trough and turns up a few days before
the security’s price turns up.
Calculation
TBelow is the formula of the %R indicator calculation, which is very similar
to the Stochastic Oscillator formula:
%R = (HIGH(i-n)-CLOSE)/(HIGH(i-n)-LOW(i-n))*100
Where:
CLOSE — is today’s closing price;
HIGH(i-n) — is the highest high over a number (n) of previous periods;
LOW(i-n) — is the lowest low over a number (n) of previous periods.
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