Sunday 17 February 2008

Technical Indiactors - An Overview

A Summary of Basic Technical Indiactors

... and how they work in planning entries and exits, either going long or short. Courtesy of AlphaTrade. Please note that some of these may vary slightly from those that you use.


Simple Moving Average (SMA):

A moving average is an indicator that shows the average value of a security's price over a period of time. A Simple Moving Average is calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. The result is the average price of the security over the time period. Simple Moving Averages give equal weight to each price. A buy signal (upward arrow) is generated when the security's price rises above its moving average, and a sell signal (downward arrow) is generated when the security's price falls below its moving average.


Exponential Moving Average (EMA):

An Exponential Moving Average is calculated by applying a percentage of today's closing price to yesterday's moving average value. Exponential Moving Averages place more weight on recent prices. Buy and sell signals are as above.


Bollinger Bands (BB):

These are envelopes that surround the price line on a chart. They are typically plotted at standard deviation levels above and below a simple moving average line, which is also plotted on the chart. Since standard deviation is a measure of volatility, the bands are self-adjusting - widening during volatile markets and contracting during calmer periods. Bollinger Bands do not generate buy or sell indicators on their own. They should be used with another indicator, such as Relative Strength Index, MACD or On Balance Volume. When combined with another indicator, they can indicate whether a trend will continue or a reversal is imminent. For example, if the price touches the upper BB and the RSI is below 70 (meaning its not overbought; see RSI below), this is an indication that the trend will continue; an RSI over 70 would suggest that the security is overbought and a reversal is likely. Conversely, if the price touches the lower BB and the RSI is above 30 (not oversold), then the downward trend will likely continue; similarly, an RSI under 30 would suggest that the security is oversold, and a reversal is likely.


Median Price (MP):

This indicator is simply the midpoint of each day's price (the average of the High and Low for each day). It provides a simple, single-line chart of the day's "average price." This average price provides a simpler view of prices.


Typical Price (TP):

Same as the Median Price, except the line represents the average of the High, Low and Close prices. It is a building block of the Money Flow Index.


Weighted Close (WC):

Same as the Typical Price, except the Close is given extra weight in the calculation.


Parabolic SAR (PSAR):

PSAR should only be employed in trending markets. It will help identify entry and exit points. Stop losses are calculated and graphed as follows: a stop level below the current price indicates a long position; a stop level above the current price indicates a short position. It is important to follow a trend indicator such as a moving average in conjunction with PSAR. Do not use PSAR when the price is ranging around the moving average. Once an upward or downward trend is established, then the PSAR will identify entry and exit points.


Moving Average Convergence/Divergence (MACD):

MACD uses different exponential moving averages to generate buy and sell indicators. The lower pane of the chart shows two lines: a Differential Line and a Signal Line. The Differential Line is the difference between a short and long-period exponential moving average, typically 12 and 26 periods. The Signal Line is typically a 9-period exponential moving average. When the DL crosses the SL from above, a sell indicator is generated, and when it crosses from below a buy signal is generated.


MACD-Histogram:

The MACD-Histogram represents the difference between MACD and it's signal line (usually the 9-day EMA of the MACD). The plot of this difference is presented as a histogram, making centerline crossovers and divergences easily identifiable. Whenever MACD crosses the signal line, MACD-Histogram crosses the zero line.

Sharp increases in the MACD-Histogram indicate that MACD is rising faster than its 9-day EMA and upward momentum is strengthening. Sharp declines in the MACD-Histogram indicate that MACD is falling faster than its moving average and downward momentum is increasing.

Divergences between MACD and MACD-Histogram are the main tool used to anticipate crossovers. A positive divergence in the MACD-Histogram indicates that MACD is strengthening and could be on the verge of a bullish moving average crossover. A negative divergence in the MACD-Histogram indicates that MACD is weakening and can act to foreshadow a bearish moving average crossover in MACD.


Relative Strength Index (RSI):

This is a momentum indicator that measures a security's price in relation to itself. The lower pane of the chart shows a line that fluctuates on a scale of 0 to 100. Typically buy signals are generated at 30 and sell signals are generated at 70. If the line breaks 30, the security is oversold, and a reversal is imminent. If the line breaks 70, it is overbought and is due for a downward correction.


Accumulation/Distribution (A/D):

This is a momentum indicator that takes into account changes in volume and price. The idea is that a change in price coupled with an increase in volume will help confirm market momentum in the direction of a price change. The AD line is shown below the chart. If the indicator moves upward, buyers are driving the price; the security is being accumulated. If the indicator moves downward, sellers are driving the price; the security is being distributed.


Detrended Price (DPO):

This is a technical indicator used to smooth the trend in prices. A x-period moving average is calculated and centered at zero. The indicator will then oscillate above and below this value, depending on underlying cyclical movements in price. This will smooth effects of overall market movements on the cyclical trend of the security.


Momentum (MOM):

This indicator measures the rate of change in the price of the charted security. The lower pane plots the difference between the latest closing price and the closing price x days ago. The central line is the rate of change for the first day of the chart, and all subsequent days oscillate around this value. The standard on the chart is 30, but any number can be selected with the configuration option.


On Balance Volume (OBV):

This indicator is used to identify and confirm trends in a stock price. On Balance Volume creates a fluctuating line shown in the lower pane of the chart. Day one of the chart starts at zero. If the day closes with a positive change, the day's volume is added to the zero. Conversely, a down day's volume is subtracted from zero. This continues in a cumulative manner for the length of the chart. A large increase in volume with a positive close will increase the OBV line rapidly, confirming the upward trend. Divergence is also used with the OBV. If the OBV line is decreasing while the price is increasing, the rally may not be as strong as it appears.


Williams A/D (W A/D):

This is another momentum indicator, similar to the Accumulation / Distribution above. Use divergence between the WAD and the price to identify selling and buying opportunities. If the price rises while the WAD falls, this is a sell signal. If the price is falling while the WAD is rising, buying is recommended.


Williams %R (W %R):

This is a momentum indicator plotted upside down using negative numbers. Similar to the Relative Strength index, oversold conditions are indicated by values in the -80 to -100 region, with overbought conditions signaled by a value in the 0 to 20 range.


Fast Stochastic (FS) / Slow Stochastic (SS):

Both the Fast Stochastic and Slow Stochastic oscillators are used by market technicians as a timing indicator for signals of market reversal. The Fast Stochastic will provide more signals (i.e. less smoother) than the Slow Stochastic, although some analysts prefer the Slow Stochastic, believing it is less prone to whipsaws.

Introduced by George C. Lane, the Stochastic Oscillator is a technical indicator which compares a stock's closing price to its price range over a given period of time. The belief is that in rising market stocks will close near their highs, while in a falling market they will close near their lows.

The Stochastic indicator is plotted as two lines, the main line %K and the second line %D, a moving average of %K. There are 3 popular ways to interpret a Stochastic Oscillator:
1. 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) then falls below that level.
2. buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.
3. Look for divergences. e.g. where prices are making a series of new highs and the Oscillator is failing to surpass its previous highs.


Money Flow Index (MFI):

The MFI is a momentum indicator that measures the strength of money flowing in and out of a security. It is related to the Relative Strength Index (RSI), but whereas the RSI incorporates only prices, the MFI accounts for volume. Typically, if the price trends higher and the MFI trends lower (or vice versa), a reversal may be imminent. When the MFI is above 80, market tops are likely to occur. When the MFI is below 20, market bottoms are likely to occur.


Commodity Channel Index (CCI):

The CCI measures price in relation to its moving average. This will highlight over bourght/over sold conditions on to signal weakening trends. Typical rule of thumb: go long if CCI turns up from below -100 and go short if CCI turns down from above 100.


Chande Momentum Oscillator (CMO):

The CMO is an advanced momentum oscillator derived from linear regression. Increasingly high values of CMO may indicate that prices are trending strongly upwards. Conversely, increasingly low values of CMO may indicate that prices are trending strongly downwards. CMO is related to MACD and Rate of Change (ROC).


Relative Momentum Index (RMI):

The RMI is a variation of the Relative Strength Index (RSI). Instead of counting up and down days from close to close as the RSI does, the RMI counts up and down days from the close relative to the close x-days ago (where x is not necessarily 1 as required by the RSI). So as the name of the indicator reflects, "momentum" is substituted for "strength." The RMI is analyzed in the same way the RSI. It usually leads the price by forming peaks and valleys before the price data, especially around the values of 30 and 70 (within the range of 1 to 100). In addition, when the RMI diverges from the price, the price will eventually correct to the direction of the index.


Rate of Change (ROC):

The ROC measures a security's percentage change in price over a fixed period of time. If the prices increase in this period, the ROC will be a positive number; and a negative number with decreased prices. The ROC can be used as an excellent short-term to intermediate-term overbought/oversold study. Higher ROC values indicate an overbought contract. Lower ROC values indicate a possible rally. (A word of caution must be issued when using overbought/oversold studies: it is wise to wait for the market to correct before placing a trade. In spite of all expectations, markets that appear overbought may remain overbought for some time, and extreme overbought/oversold situations often suggest a continuation of the current trend.)


Q Stick (QSTK):

The Q Stick indicator is simply a moving average of the difference between open and close prices over a given period of time. It was developed to quantify the information displayed in candlestick charting: Segments of the chart with mostly white/blank candlesticks (indicating an increase in price from open to close) are typically uptrending and segments with mostly red/solid candlesticks (indicating a decrease) are typically downtrending. As with other momentum indicators, the Q Stick indicator can be traded in several ways. Entry/Exit signals could be generated when the value crosses zero or crosses a moving average of itself. In addition, divergences from the price can indicate overbought/oversold conditions, which may signify an upcoming trend reversal.


Directional Movement Indicator (DMI):

Developed by Welles Wilder, the DMI helps determine how strong the directional movement (trend) is in a security. It is comprised of three components. The first ADX (Average Directional Index) rates the directional movement (trend) of a stock on a scale of 0-100. Generally speaking the higher the number the more a stock is trending and the more it is a candidate for a trend following system. The next two components help decipher what the trend is showing. +DI (Plus Directional Movement Index) is a measure of upward or positive movement in a stock. -DI (Minus Directional Movement Index) is a measure of negative or downward movement in a stock.

Wilder suggests buying when +DI rises above -DI and selling when +DI falls below -DI. The ADX line is then used to measure the strength of these signals. Wilder also uses what he calls the 'extreme point rule'. Don't buy or sell on the day the +DI crosses above or below the -DI. Rather, note the high (when the price is moving up) or low (when moving down) of the day. Then, wait to execute the trade until on a subsequent day the price reaches the high (to buy) or the low (to sell).


Plus Directional Movement (+DI):

Plus Directional Movement Index represents the difference between today's high and yesterdays high. It is one of the three components of Directional Movement Indicator.


Minus Directional Movement (-DI):

Minus Directional Movement Index represents the difference between today's low and yesterday's low. It is one of the three components of Directional Movement Indicator.


Average Directional Index (ADX):

The ADX measures the strength of directional movement (trend) in a security. It is one of the three components of Directional Movement Indicator.