Parabolic SAR
Parabolic SAR is a system that always has a position in the market, either long or short. You would close out the current position and enter a reverse position when the price crosses the current Stop And Reverse (SAR) point.
Parabolic SAR is usually charted with a bar chart so that the stop and reverse points are easily identified. The SAR points resemble a parabolic curve as they begin to tighten and close in on prices once prices begin to trend. If you are long, the SAR points will be below the prices, and the signal to go short will be when prices cross the current SAR point from above. If you are short, the SAR points will be above the prices, and the signal to go long will be when prices cross the current SAR point from below.
When a new position is entered, the SAR points will be positioned far enough away from the prices to permit some contra-trend price movement. As the market begins to trend, the SAR points will move with prices and progressively tighten as the trend continues. This is accomplished by the use of an acceleration factor that increases up to a given limit each time a new extreme in the direction of the trend is reached.
Uses
The most common uses of Parabolic SAR are as a:
Stop and Reverse system. Signals to exit the current position and enter a reverse position occur when prices cross the current SAR point. For example, if the SAR points are below prices you would exit the current long position and enter a short position at that period’s SAR point. Once you are stopped into a short position, the SAR points will be above prices and the current period’s SAR point will be at the level at which you will be stopped out of your short position and enter a long position.
When applied in its original form, Parabolic SAR is a system that is always in the market. In order for this technique to be successful, the underlying market needs to be trending strongly.
If Parabolic SAR is applied in a non-trending market, then it is likely that losses will result because the buy signals will occur at the top of the range and the sell signals at the bottom of the range.
Entry and exit technique in a trending market. By using Parabolic SAR in conjunction with an analysis that indicates market trend such as Directional Movement Index, you would take only long trades when the trend was up and only short trades when the trend was down.
After a trade has been entered using another method or technique, the SAR points of Parabolic SAR are used to trail a stop on the position.
MACD
Moving Average Convergence Divergence (or “MACD” as it is more commonly known) is a type of oscillator that can measure market momentum as well as follow or indicate the trend. MACD consists of two lines, the MACD Line and the Signal Line. The MACD Line measures the difference between a short moving average and a long moving average. The Signal Line is a moving average of the MACD Line. MACD oscillates above and below a zero line without upper and lower boundaries.
There is another form of MACD which displays the difference between the MACD Line and the Signal Line as a forest. For further information click the “MACD Forest analysis” link in the Related Topics list at the bottom of this page.
Uses
The most common uses of MACD are to:
Generate buy and sell signals. Signals are generated when the MACD Line and the Signal Line cross. A buy signal is generated when the MACD Line crosses from below to above the Signal Line, the further below the zero line that this occurs the stronger the signal. A sell signal is generated when the MACD Line crosses from above to below the Signal Line, the further above the zero line that this occurs the stronger the signal.
Indicate trend direction. If a trend is gaining momentum then the difference between the short and long term moving average will increase. This means that if both MACD lines are above (below) zero and the MACD Line is above (below) the Signal Line, then the trend is up (down).
Indicate bullish and bearish divergence. Divergence between the MACD and the price indicates that an up or down move is weakening.
Bearish divergence is when prices are making higher highs but the MACD is making lower highs. This is a sign that the upmove is weakening.
Bullish divergence is when prices are making lower lows but the MACD is making higher lows. This is a sign that the downmove is weakening.
It is important to note that although divergences indicate a weakening trend, they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trendline break.
Stochastics Analyses
Stochastics are oscillators based on the following observation:
· As prices increase, closing prices tend to be closer to the upper end of the price range.
· As prices decrease, closing prices tend to be closer to the lower end of the price range.
Each Stochastic uses two lines, %K and %D. The difference between Fast and Slow Stochastics is in the calculation of the %K and %D lines. Slow Stochastics is a slower and smoother form of Fast Stochastics.
Types of Stochastic Analyses:
There are two types of Stochastics: Fast and Slow
Uses
The most common uses of Stochastics are to:
Indicate overbought and oversold conditions. An overbought or oversold market is one where the prices have risen or fallen too far and are therefore likely to retrace. If the %D line is above 80% then the close is near the top end of the range of the observation period, while a reading below 20% means that the close is near the bottom end of the range of the observation period.
Generally the area above 80 is considered overbought, while the area below 20 is oversold. The specified overbought/oversold ranges vary. Other commonly used ranges include 75-25, 70-30 and 85-15.
Overbought and oversold signals are most reliable in a non-trending market where prices are making a series of equal highs and lows. If the market is trending, then signals in the direction of the trend are likely to be more reliable. For example, if prices are in an uptrend, a safer trade entry may be obtained by waiting for prices to pullback giving an oversold signal and then turn up again.
Generate buy and sell signals. For a buy or sell signal the following conditions must be met in order.
1. The %K and %D lines move above 80 or below 20
2. The %K and %D lines cross each other
3. The %K and %D lines move below 80 or above 20
Indicate bullish and bearish divergence. Divergence between Stochastics and the price indicates that an up or down move is weakening.
Bearish divergence is when prices are making higher highs but the Stochastics are making lower highs. This is a sign that the upmove is weakening.
Bullish divergence is when prices are making lower lows but the Stochastics are making higher lows. This is a sign that the downmove is weakening.
It is important to note that although divergences indicate a weakening trend they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trendline break.
Relative Performance
A Relative Performance analysis compares the performance of two instruments from a specified starting date/time to the present. It shows whether the first instrument is rising or falling at a faster or slower rate than the second instrument.
Uses
The most common use of Relative Performance is to compare the performance of an instrument against a market index such as the Dow Jones Average. This is a performance indicator – not an indicator that tells you when to buy and sell.
Another use for this tool is to analyze the ranking of individual groups of stock. For instance, you could use Relative Performance to determine whether the stock index is out-performing the commodities index, or if the oil sector is out-performing the gold sector.
If the Relative Performance value is above 1 then the first instrument is outperforming the second instrument. If the Relative Performance value is below 1 then the first instrument is underperforming the second instrument.
Correlation
Correlation is the degree of association between two variables. If there is a close relationship then it is possible to predict the price movement of one instrument from the price movement of the other. Correlation is a useful tool in the management of risk in a portfolio.
Uses
The most common uses of Correlation are to:
Determine the predictive ability of an indicator. When comparing the correlation between an indicator and an instrument’s price, a high positive coefficient (e.g., more than +0.70) tells you that a change in the indicator will usually predict a change in the instrument’s price. A high negative correlation (e.g., less than -0.70) tells you that when the indicator changes, the instrument’s price will usually move in the opposite direction. Remember, a low (e.g., close to zero) coefficient indicates that the relationship between the instrument’s price and the indicator is not significant.
Determine the correlation between two securities. Correlation analysis is also valuable in gauging the relationship between two instruments. Often, one instrument’s price “leads” or predicts the price of another instrument. For example, the correlation coefficient of gold versus the dollar shows a strong negative relationship. This means that an increase in the dollar usually predicts a decrease in the price of gold.
Commodity Channel Index
The Commodity Channel Index (CCI) analysis is based on the assumption that a perfectly cyclical commodity price approximates a sine wave. Designed to be used with instruments which have seasonal or cyclical tendencies, Commodity Channel Index is not used to calculate cycle lengths but rather to indicate that a cycle trend is beginning.
Uses
The most common uses of the Commodity Channel Index are to:
Indicate breakouts. This is Lambert’s original interpretation, buying when the Commodity Channel Index moved above +100 and selling when the Commodity Channel Index went below -100. Lambert would exit the trade once the Commodity Channel Index moved back within the -100 to +100 bands. The assumption with this use of the Commodity Channel Index is that once an instrument breaks +100 or -100 it has begun to trend.
Generate buy and sell signals. Sell signals are when the CCI moves from above +100 to below +100, and buy signals are when the CCI moves from below -100 to above -100. This method works best when the market is non-trending.
Indicate bullish and bearish divergence. In trending markets the Commodity Channel Index can be used to indicate that the trend is weakening by signalling divergence. Divergence between the CCI line and the price indicates that an up or down move is weakening.
Bearish divergence is when prices are making higher highs but CCI is making lower highs. This is a sign that the upmove is weakening.
Bullish divergence is when prices are making lower lows but the CCI is making higher lows. This is a sign that the downmove is weakening.
It is important to note that although divergences indicate a weakening trend, they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example when prices break a trendline.
Relative Strength Index
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.
The name “Relative Strength Index” is slightly misleading, as the RSI does not compare the relative strength of two instruments, but rather the internal strength of a single security. A more appropriate name might be “Internal Strength Index.”
Because you can vary the number of time periods in the RSI calculation, you may want to experiment to find the period that works best for you. (The fewer days used to calculate the RSI, the more volatile the indicator.)
Wilder Smoothing in an RSI Analysis
Wilder Smoothing is similar to a Exponential Moving Average analysis. It responds slowly to price changes compared to other moving averages.
Uses
The most common uses of RSI are to:
Indicate overbought and oversold conditions. An overbought or oversold market is one where prices have risen or fallen too far and are therefore likely to retrace.
If the RSI is above 70 then the market is considered to be overbought, and an RSI value below 30 indicates that the market is oversold. 80 and 20 can also be used to indicate overbought and oversold levels.
Overbought and oversold signals are most reliable in a non-trending market where prices are making a series of equal highs and lows. If the market is trending, then signals in the direction of the trend are likely to be more reliable. For example, if prices are in an uptrend, a safer trade entry may be obtained by waiting for prices to pullback giving an oversold signal and then turn up again.
Identify failure swings. For example, a failure swing would be if the RSI formed a high above 70 then retraced to form a pivot low before rallying to form a second high. The second high fails to exceed the first before the RSI reverses taking out the pivot low formed between the highs.
Generate buy and sell signals. If the RSI is above 70 and you are looking for the market to form a top, then the RSI crossing back below 70 can be used as a sell signal. The same is true for market bottoms, buying after the RSI has moved back above 30. These signals are best used in non-trending markets.
In trending markets, the most reliable signals will be in the direction of the trend. For example, if the market is trending up, taking only buy signals after the RSI has moved back above 30 after dipping below it. The reason for taking signals only in the direction of the trend, is that when the market is trending any counter-trend signal is likely to indicate a small retracement against the underlying trend rather than true reversal.
Indicate bullish and bearish divergence. Divergence between the RSI and the price indicates that an up or down move is weakening.
Bearish divergence is when prices are making higher highs but the RSI is making lower highs. This is a sign that the upmove is weakening.
Bullish divergence is when prices are making lower lows but the RSI is making higher lows. This is a sign that the downmove is weakening.
It is important to note that although divergences indicate a weakening trend they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trendline break.
Majority Rule
A Majority Rule analysis calculates the percentage of periods over the observation period that the instrument had rising values.
Uses
The most common uses of Majority Rule are to:
Confirm the underlying trend. A rising Majority Rule would indicate an uptrend, while a falling Majority Rule would indicate a downtrend.
Indicate an overbought or oversold market. An overbought or oversold market is one where the prices have risen or fallen too far and are therefore likely to retrace. Very high values would indicate an overbought market and very low values would indicate an oversold market. An overbought market would have a very high Majority Rule value, and an oversold market a very low Majority Rule value.
Alpha-Beta Trend
Alpha-Beta Trend analysis is an attempt to avoid some of the false signals associated with crossing moving averages. Three lines are plotted:
· Upper band
· Lower band
· Trading filter
Together, the upper and lower bands define the uncertainty channel for trade decisions; the width of the channel varies with volatility.
Uses
The most common uses of the Alpha-Beta Trend are to:
Generate buy and sell signals. If the trading filter moves from within the bands to below the lower band, this is a signal to buy or enter a long position. If the trading filter moves from within the bands to above the upper band, this is a signal to sell or enter a short position.
Determine the trend. If the trading filter lies between the bands, no trend is indicated. An uptrend is when the trading filter is below the lower band. A downtrend is when the trading filter is above the upper band.
Stochastic Momentum Index
The Stochastic Momentum Index (SMI) shows you where the close is relative to the midpoint of the recent high/low range. The SMI is smoothed twice by exponential moving averages. The result is an oscillator that ranges between plus or minus 100.
Uses
The most common uses of Stochastic Momentum Index are to:
Generate buy and sell signals.
· Buy when the SMI falls below a specific level (e.g., -40) and then rises above that level, and sell when it rises above a specific level (e.g., +40) and then falls below that level. However, before basing any trade on strict overbought/oversold levels, first qualify the trendiness of the market using the Vertical Horizontal Filter. If this indicator suggests a non-trending market, then trades based on strict overbought/oversold levels should produce the best results. If a trending market is suggested, use the oscillator to enter trades in the direction of the trend.
· Buy when the SMI rises above its signal line (for example, a 3-period moving average) and sell when it falls below the signal line.
Identify divergences. For example, a divergence would be suggested if prices are making a series of new highs and the SMI is failing to surpass its previous highs.
Identify a trend. Blau also notes that a 1-day SMI (with large smoothing periods, such as 100) is very sensitive to the closing price relative to the high and low of the day. These types of parameters make the RMI useful as a sentiment, or trend-identification indicator, thereby providing a better sense of the overall direction of the market.
Kairi
The Kairi analysis charts the percentage difference between a price and a Simple Moving Average of that price.
Uses
The most common uses of Kairi are to:
Give buy and sell signals. These are generated when the Kairi crosses above and below zero. A buy signal is generated when the Kairi moves from below to above the zero line, and a sell signal is generated when the Kairi moves from above to below the zero line.
Indicate bullish and bearish divergence. Divergence between Kairi and the price indicates that an up or down move is weakening.
Bearish divergence is when prices are making higher highs but the Kairi is making lower highs. This is a sign that the upmove is weakening.
Bullish divergence is when prices are making lower lows but the Kairi is making higher lows. This is a sign that the downmove is weakening.
It is important to note that although divergences indicate a weakening trend, they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trendline break.
Relative Momentum Index
The Relative Momentum Index (RMI), developed by Roger Altman, is a variation on the Relative Strength Index (RSI) that adds a momentum component. 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 n periods ago (this is the momentum parameter, which is not necessarily 1 as required by the RSI). So as the name of the indicator reflects, “momentum” is substituted for “strength.”
Uses
The most common use of Relative Momentum Index is to identify overbought or oversold conditions.
As an oscillator, RMI exhibits the same strengths and weaknesses of other overbought/oversold indicators. During strong trending markets, the RMI will remain at overbought or oversold levels for an extended period. However, during non-trending markets, the RMI tends to oscillate predictably between an overbought level of 70 and an oversold level of 10 to 30.
Since the RMI is based on the RSI, many of the same interpretation methods can be applied. In fact, many of these “situations” are more clearly manifested with the RMI than with the RSI.
Tops and Bottoms. The RMI usually tops above 70 and bottoms below 30. The RMI usually forms these tops and bottoms before the underlying price chart.
Chart Formations. The RMI often forms chart patterns (such as head and shoulders or rising wedges) that may or may not be visible on the price chart.
Failure Swings. (Also known as support or resistance penetrations or breakouts.) This is where the RMI surpasses a previous high (peak) or falls below a recent low (trough).
Support and Resistance. The RMI shows, sometimes more clearly than the price chart, levels of support and resistance.
Divergence. This occurs when the price makes a new high (or low) that is not confirmed by a new RMI high (or low).
Note: A 20,1 parameter RMI is equivalent to a 20-period RSI. This is because the 1-day momentum parameter is calculating day-to-day price changes, which the standard RSI does by default. As the momentum parameter is increased, the oscillation range of the RMI becomes wider and the fluctuations become smoother.
Momentum
A Momentum analysis is an oscillator that measures the rate at which prices are changing over an observation period (as defined in the parameters). It measures whether prices are rising or falling at an increasing or decreasing rate. The Momentum calculation subtracts the current price from the price a set number of periods ago. This positive or negative difference is plotted above or below a zero line.
Uses
The most common uses of Momentum are to:
Indicate overbought and oversold conditions. An overbought or oversold market is one where the prices have risen or fallen too far and are therefore likely to retrace. If the Momentum line moves to a very high value above the zero line, this is a sign of an overbought market. If the Momentum line moves to a very low value below the zero line this is a sign of an oversold market.
Overbought and oversold signals are most reliable in a non-trending market where prices are making a series of equal highs and lows. If the market is trending, then signals in the direction of the trend are likely to be more reliable. For example, if prices are in an uptrend, a safer trade entry may be obtained by waiting for prices to pullback giving an oversold signal and then turn up again.
Indicate bullish and bearish divergence. Divergence between the Momentum line and the price indicates that an up or down move is weakening.
Bearish divergence is when prices are making higher highs but the Momentum is making lower highs. This is a sign that the upmove is weakening.
Bullish divergence is when prices are making lower lows but the Momentum is making higher lows. This is a sign that the downmove is weakening.
It is important to note that although divergences indicate a weakening trend, they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trendline break.