Indicator - is a result of mathematical
calculations on the basis of price and/or volume indicators or a combination of
both. The received values are used for forecasting price changes. In the world there is a considerable quantity (over 1000) of the technical indicators,
some of them are presented in the information-trading system «iTrader».
Prior to beginning to familiarize with indicators, we will
consider such concept, as divergence. Divergence is by rights considered the
strongest signal in the technical analysis and it is formed in case of
discrepancy in the prices and indications of the chart. When prices rise to a new
maximum, and the indicator chart stops at a lower rate, is formed a bearish
divergence (fig. 1).
The bearish divergence between the indicator and
prices specify in the weakness of market’s top and give a signal about a high
probability of tendency reverse.
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| Fig.1. The schematic image of bearish divergence |
If the prices fall to a new minimum and the indicator chart shows the rate higher than the previous one, bullish divergence is formed (fig. 2).
Bullish divergence between the indicator and the
prices denote the descending tendency weakness and give a signal of the
growth beginning probability.
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| Fig.2. The schematic image of bullish divergence |
Generally, all indicators can be divided into two groups:
- Trend indicators
- Oscillators
Let's consider indicators referred to as trends.
The Moving Average indicator is the most frequently
used indicator in technical analysis. Moving average is counted within a certain period. The less is period, the false signals are more probable. The
more is period, the moving average sensitivity is lower.
Variants of moving averages:
- Simple Moving Average
- Weighted Moving Average
- Exponential Moving Average
Moving average value (MA) concerns a category of
analytical tools which follow the tendency. Its purpose consists in defining new tendency beginning time and also to warn about its end or turn. MA is
intended for tendencies tracing in the process of their development, they can
be considered as the curved trend lines.
However, MA is not intended for market
movements forecasting as graphic analysis because it always follows the market
dynamics instead of advances it. This indicator does not predict the prices
dynamics but only reacts to them. It always follows the market prices movements
and signals about the new tendency beginning but only after it has appeared.
MA
construction is a special method of price indicators smoothing. Really, at
averaging of price indicators their curve considerably smoothes out, and it is
easier to observe the tendency of market development. However already by nature MA as though lags behind the market dynamics.
Short-term MA transfers the movement of the prices more precisely than permanent long MA. Application
short MA allows to reduce time lag, however, completely eliminating it by means
of MA is impossible. In the lateral markets it is more expedient to use
short MA, and on trends is more effective long, as less sensitive.
Simple Moving Average
Simple MA or average arithmetic value is calculated
by the following formula:
where Рi - the price of the day, n - a moving
average order.
This type of MA is widely used by the majority of
technical analysts. However, some analysts dispute its advantages, putting
forward thus two basic arguments. The first argument is that the analysis
takes into account the only time interval covered by this MA.
The second argument is that the simple MA actually equalizes each day prices
importance. For example, at the use of a ten-day moving average, the identical
weight of 10 % is assigned to the last and first days, as well as to all other
days of the period.
Five-day MA, in turn, means that the daily average price
weight is equal to 20 %. At the same time, some analysts believe that later price
indicator should have a greater value. This argument is quite logical, as at
the new tendency simple MA is required more time for a turn and signal giving,
than for weighed MA, considered below.
Weighted Moving Average.
To solve the problem of the prices average values
"specific weight", some analysts use the weighted moving averages (WMA). They calculated by the following
formula:
where Wi - the weight of the component (price).
Weight can linearly increase, exponential or
otherwise. In the case of linearly-weighed MA Wi=i.
Exponential Moving Average.
Exponential Moving Average (EMA) has more difficult
construction than WMA or simple MA which allows EMA to eliminate two
disadvantages of simple MA. First, EMA attaches much more importance to the
last days’ indicators.
Therefore it is weighed. But, though the smaller weight
is given to the previous prices dynamics, at calculation all prices data for
all period of equity market operation is
used. The formula of this MA type calculation is more difficult and looks as
follows:
EMAt=EMAt-1 +(k*(Pt -
EMAt-1)),
where t-today's, t-1 - yesterday, k=2 / (n+1), where
n - MA order.
Despite that EMA has no disadvantages, inherent
simple MA, it is not the best of three MA. Below thanks to testing efficiency of
every MA will be shown.
Analysis rules.
The general rules of MA analysis are the following:
1. The most important signal showing a trend direction
is the general direction of the MA movement. At ascending MA it is necessary to
adhere to the bull market and to work on the increase. It is necessary to buy when
the prices will fall to MA, putting Stop Loss (SL) below the previous minimum,
and to move it as soon as the prices will be closed above the previous level.
At descending MA it is necessary to speculate for a fall, opening short
positions when the prices will jump up to MA or slightly above. In that case, SL
should be placed slightly above the previous crest and dynamically to move it
in case of the bear trend continuation.
The second signal is the intersection of MA and the price graph. Such a signal is strong for the outlined bull market if MA crosses
the price chart on top with a positive incline and the price chart also has
the significant incline.
2. In the case of MA and the price chart intersection at the negative incline of the first and an insignificant positive or negative incline
of the second, it is a weaker signal on outlined bull trend, and it is
necessary to receive acknowledgement of future dynamics from an additional
signal. There are similar signals for the outlined bear market, but with the
inverse arrangement and MA inclination and price chart.
3. The third signal is the MA reverse at the minimum
or maximum value. If MA is located under the price chart and has a local
minimum and the price chart has a positive inclination the average force signal
about the bull direction of the market and about upwards position opening; if
the chart has no positive inclination, there is a very weak signal for its
confirmation it is necessary to use three additional signals. These rules may
be used on the trend markets. On the market without a revealed trend
corresponding graph will have bends. Attempt to filter these bends mechanically
leads, as a rule, to useful signal loss.
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| Fig. 3. There are three types of moving averages on the chart. The intersection of the chart by the price at the bottom gives a signal for buying. |
----------- simple moving average
----------- exponential
moving average
----------- weighted
moving average
MACD (Moving Average Convergence/Divergence)
The moving average convergence/divergence (MACD) is
a dynamic indicator following the tendency. It shows a correlation between two
moving averages of the price. MACD indicator makes as a difference between two
exponential moving averages (EMA) with the periods in 12 and 26 days on
default. In order to identify favourable moments to buy or sell, the so-called signal line is put on the MACD graph - 9 EMA from MACD Line with smoothing by
default 9.
A calculation of the histogram from EMA with
smaller order (12) it is deducted EMA with the bigger order (26), and then from
the received result 9-day EMA is deducted from difference EMA with order 12 and
EMA with order 26:
MACD=EMA(P,12) –EMA(P,26) – EMA[(EMA(P,12) –EMA(P,26))9]
where P - price, EMA (P, n) - EMA with n order
The obviousness and efficiency of these two MA analysis
method permitted to win great popularity among modern analysts. The best
results MACD shows at its analysis on time intervals from the day and more.
It is
necessary to be more careful at MACD analysis on the less than day periods. The
periods less than an hour also contain information but may include many false
signals.
MACD is most effective in conditions when the
market fluctuates with a big amplitude in a trading range. The most often
used MACD signals - intersections, overbought/oversold conditions and
divergences.
All MACD signals can be divided into three
categories on the degree of their value:
Trade on MACD intersections.
The simplest way of MACD usage is to trade on its
basic components intersections. Signals to buy are generated, when the
histogram crosses the zero lines at the bottom and sells on the contrary.
It is
necessary to warn that in most cases mechanical trade on each MACD intersection
gives frequent jerks that lead to considerable losses. It is necessary to avoid
narrow trading ranges, effected destructive to the indicator.
Try to buy, when
the signal on buy is generated almost at zero line level. In most cases, it is
preceded by a strong bullish trend. If a similar signal is generated much
lower reference line level the trend will be very weak. At the MACD histogram analysis, it is possible to receive additional
information.
So, if the bar (histogram column) is much lower reference line
level and there comes a situation when each subsequent bar gradually decreases
in size, it is necessary to take into consideration moment reduction.
Reflecting on the moment indicator, the histogram gives earlier signals.
Divergence
Divergence is the second way of MACD usage.
Divergence itself is a very effective form of the majority of technical researches
and MACD is no exception. Divergence appears when the direction of price movement
is diametrically opposed to the direction MACD lines.
Usage of this signal is
more useful for indication of trend continuation after the correction than as a
signal of a trend reversal. Anyway, it is better not to run before the hounds but
wait until the divergence reaches the steady states. Otherwise, you will feel
worth it if you turn out to be on the opposite side of the strong trend.
Overbought/oversold
The third variant of indicator MACD usage is market
overbought/oversold analysis. This instrument allows with the specified degree
of accuracy to set the points where market subjects to reverse. If MACD reaches
the points of extremum placed at the opposite sides from the reference line, it
means that the market is oversold or overbought. Considering this type of signals,
it is ought to set the points of extremum empirically; they can be different
for each instrument.
When the bar graph reaches this critical zone, any
intersection with the signal line generates the signal for buying or selling.
Intersections, which appeared before the level of extremum, can be ignored, so
the majority of twitching will be avoided. Such levels can be determined as a
result of a simple investigation for any market which is in wide trading
congestion with huge price fluctuations.
Signals that appeared at the medium
zone of the MACD graph can be accepted only if another proven indicator confirms
that trading will be held along the trend direction. Obviously, such an indicator is some oscillator. It should be remembered, that MACD is better used
as a long-term instrument of following the trend, but not the short-term trading
timer.
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| Pic. 4. Bullish divergence at the MACD predicted trend reverse, breakthrough of the null line gave the signal for buying. |
The Average Directional Movement Index (ADX) is a Directional
system (DS) that was developed by J. Welles Wilder in the middle of the 70th
and then was developed by some analysts.
DS is used for the determination of market
trend forces. The rates of directional indicators (+DI and –DI) are used for the calculation
of ADX indications. For DS construction it is necessary to go through several
steps:
1. Determine the directional movement (DM) by
comparison of current and yesterday’s price range, the distance between the maximum
and minimum. Directional movement is the major part of the current price range
which is out of yesterday’s range.
2. Determine the true range (TR) of the market. It is
always a positive number, maximum of three:
- Distance between the current maximum and minimum.
- Distance between the current maximum and yesterday’s closing price.
- Distance between the current minimum and yesterday’s closing price.
3. Calculate the daily directional indexes (+DI and –DI).
They help to compare different markets evaluating their directional movement as
a per cent of the true range of every market. Every DI is a positive number: +DI is
equal to 0 if there is no directional movement downwards; -DI is equal to 0 if there is no directional movement upwards.
This index helps to estimate the strength of the trend. If ADX rises, it indicates that the market trend becomes stronger. At this time it is better to make deals only along the trend direction. When ADX falls, it means that trend is very weak. At this moment, signals given by oscillators have a great value.
The role of directional analysis is tracking changes in
the mass optimism and pessimism estimating the capability of bulls and bears to
take prices out of the previous days’ price range. If today’s maximal price is higher than yesterday’s one, then the market
becomes more optimistic. And vice versa, if today’s minimal price is lower than
yesterday’s minimal one, then the market becomes pessimistic.
During the DI analysis, the following signals
appear:
1. If the +DI line is above the –DI line, it indicates the
general upwards dynamics of the trend. If the +DI line is lower than the –D line, then the downtrend predominates in the market.
2. If lines diverge, dynamics of trend gains strength, if lines converge, then trend weakens
or prepares for the reverse.
There are several rules of trading using DS:
1. Buy when +DI exceeds –DI, sell when –DI exceeds
+DI. The most favourable conditions for buying are when +DI and ADX are above
–DI, and ADX rises. It indicates the uptrend consolidation. And vice versa, it
is better to sell when –DI and ADX are higher than +DI, and ADX rises.
2. ADX decrease shows that the market becomes less
directed. When ADX goes down or passes under both lines of DS, it means that the market is calm. In this situations, it is not recommended to use the DS method.
The best signal given by DS appears after ADX
falls below both lines, then goes up above them. In this case, you should be
ready for the appearance of a new bearish or bullish market. When ADX rises for 4
points, for instance, from 1 8 to 22,
from its bottom point under both lines of DS, you can say for sure about
new trend beginning. You should buy if +DI is higher setting defending stops
below the very last bottom. If –DI is higher, then you should act conversely.
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| Pic. ADX graph rising confirmed the continuation of the uptrend which was indicated at the beginning by the ascent of the +DI line, and gave a signal to buy. |
Bollinger Bands
Bollinger Bands are similar to the moving average
envelopes. However, there is a difference between them: the bounds of the envelopes
are above and under the curve of moving average at the fixed, put into
percentage distance, but bounds of Bollinger bands are constructed on the basis
of distances that are equal to a certain quantity of standard divergences.
The
value of standard divergence depends on volatility, so bands control their
width: it increases when the market is not stable, and it decreases at a stable
periods. Bollinger Bands are usually drawn on the price chart, but they can be
drawn on the indicator chart as well.
Everything said below, applies to the bands drawn on the price charts. As in the case with moving average envelopes, interpretation of Bollinger bands is based
upon the fact that prices usually stay in the range of upper and bottom bounds
of a band.
A peculiarity of Bollinger Bands is their variable width conditioned
by the price volatility. In the periods of considerable price changes (i.e.
high volatility) bands widen giving the space for prices. In periods of
stagnation (i.e. low volatility) bands converge, keeping the prices within bounds.
Peculiarities of Bollinger bands:
- Sudden price changes usually occur after the band’s stagnation indicating the decrease of volatility.
- If prices transcend the band bounds, then the current trend will continue.
- If after the peaks and cavities outside the band, the peaks and cavities inside the band follow, then the trend reversal is probable.
- Price movement started from one of the band’s bounds usually reaches the opposite bound. The last observation is useful for forecasting the price targets.
Oscillators
Momentum and ROC
Oscillator Momentum estimates the value of price
change for a certain period.
The formula for calculation:
MOM = C – Cn
Rate of Change (ROC) is the second simplest type of
oscillators' methods usage. Its
difference from Momentum consists in calculation of its rate: it is estimated
not as discrepancy, but as quotient from division of today’s closing price by
the closing price x of days ago. The general formula looks like this:
 |
Px – closing price of x days ago.
Momentum and ROC look similar on the chart and
apply almost equally. The difference is only in the scale of rates: there is a number
50 in
ROC at the place of 0 lines, and instead of positive and negative values,
fluctuation occur lower and upper of 50.
Momentum and Roc determine the acceleration of trend – speeding up or speeding down. These indicators have
anticipating character, reaching the maximum before the trend reaches it, and
minimum before the prices fall till their minimal level. While oscillators are
reaching new maximums, it is safe to keep the long position and vice versa.
Reaching more maximum, oscillator signals about the trend speeding up, and most
probably such situation will continue. When the lower peak is reached, the uptrend
weakens and you should be ready to the trend reverse. Analogical reasoning does
for minimums in the downtrend. As described above oscillators have the same
disadvantages as simple MA – they react twice at the data of each day: when
they enter the window, and when exiting it.
When these oscillators reach a new maximum, it
indicates the increase of optimism at the market: prices most probably will
rise. If prices go up, but oscillators’ rates go down, it means that the price
maximum is coming and it is time to get profit from long positions and be ready
for its reverse. There can be opposite situation too.
You should be very careful while using the leading
indicators:
1. Buy while uptrend when oscillator, having fallen
below the zero lines, starts to rise. This reflects a slowdown of the trend. Sell
while downtrend when oscillator rises above the zero lines and then start
falling.
2. New indicator’s maximum indicates high bulls’
energy, owing to this the market may reach greater maximum. In this case, you
may hold a long position with relative safety. A number of the downwards
maximums determines bulls’ mood weakening and the position should be
immediately reversed. The opposite approach is used in case of a downtrend.
3. The change of the oscillator trend line often
anticipates the change of the prices trend line for one-two days. That is why
if the change of the leading indicator line takes place you should be ready to
reverse the position. The oscillator reaches an overbought state when it has reached a higher level in comparison with the previous index.
The overbought state shows an extremely high level when the oscillator is ready to turn down. The overbought state of
the market is characterized by the situation when bulls do not want to buy or
their opportunities to buy run out and they can not raise prices to the new
high.
At that period we may observe a slack and prices do not have a severe
bullish trend. Due to the fact that bulls can not raise prices to the new level
and prices dynamics for n days has a positive slope an oscillator turns down and
after some time breaks the border of the oversold area.
This is a signal that
the trend will reverse. By analogy oversold state takes place when the oscillator
reaches a low value towards the previous ones. The oscillator is ready to start
rising.
Overbought and oversold levers are indicated at the
chats by horizontal supporting lines. The rule is to place an oscillator so that
it stays not more than 5% of the time outside the zone limited by these lines. The
lines should cross the highest tops and toughs of the oscillator for the last
six months.
Their position should be corrected every 3 months. The oscillator may
stay in the overbought zone for several weeks when a new uptrend starts and gives an early signal to sell. When we have a downtrend the oscillator stays in the
oversold zone, mistakenly advising to buy. In such situations, you should
analyse trend indicators.
As already described indicators the oscillators give
the best signals when they are different from the prices. Bullish divergence
takes place when prices rise up to the new top and the oscillator does not change
its position.
Such a situation shows that prices are rising by inertia and bulls
are played out. There is an opposite situation during bearish divergence. It
should be mentioned that triple divergences are possible for oscillators and
signals from such divergences are stronger.
The main methods of the speed oscillator usage:
1. As oscillator which follows a trend like MACD. In, this case a signal to buy occurs if an indicator forms a trough and starts to
rise; signal to sell – when it reaches a top and turns down. For a more detailed
determination of the oscillator reverse moments, it is possible to use its short
moving average.
2. Extremely high or low oscillator values presuppose
the continuation of the current trend. Thus, if an oscillator reaches extremely
high values and then turns down wу should expect the further rise of the prices. But in any situation do not
hurry to close or open position before the prices prove the oscillator signal.
3. As a leading indicator. This method is based on the supposition that the final stage of the uptrend is usually accompanied by the
rapid prices’ growth (because everybody believes in the growth continuation),
bearish market closing is usually accompanied by their rapid fall (because
everybody tries to leave the market).
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| Pic.6 Registration MOM and ROC are very similar, the possibility of the direction change is determined after the upper borders of the interval are reached. Divergence became a strong signal for confirmation of the trend change. |
RSI (Relative Strength Index) – is a financial technical analysis momentum oscillator measuring the velocity and magnitude of directional price movement by comparing upward and downward close-to-close movements. The RSI ranges from 0 to
One of the
popular methods of RSI analysis lies in the search for divergence
when a price generates a new maximum and RSI does not manage to overcome the
level of its previous maximum. Such a difference indicates the possibility of the reversal of the price. If RSI turns down and falls below its trough it completes “a
failure swing”.
The failure swing is considered a confirmation of
the impending reversal.
Ways to use Relative Strength Index for chart
analysis:
The Relative Strength Index usually tops above 70 and bottoms below 30. It usually forms these tops and bottoms before the underlying price chart;
2. 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 takes place when RSI rises above the previous maximum or falls below the previous minimum.
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 takes place when RSI rises above the previous maximum or falls below the previous minimum.
3. Support and Resistance levels
The Relative Strength Index shows, sometimes more clearly than price themselves, levels of support and resistance.
The Relative Strength Index shows, sometimes more clearly than price themselves, levels of support and resistance.
4. Divergences
As discussed above, divergences occur when the price reaches a new maximum (or minimum) that is not confirmed by a new maximum (or minimum) in the Relative Strength Index. Prices correction takes place in the direction of the RSI.
As discussed above, divergences occur when the price reaches a new maximum (or minimum) that is not confirmed by a new maximum (or minimum) in the Relative Strength Index. Prices correction takes place in the direction of the RSI.
In June 1 978
Welles Wilder introduced the Relative Strength Index (RSI),
which is a widespread oscillator. RSI is one of the most popular and famous
among all oscillator methods. There is not only a standard oscillator analysis
set but also a graphical analysis with the support, resistance and tendency
lines, described above.
The formula for oscillator amount calculations is
following:
RSI = 1 00 - [1 00/(1 +RS)]; RS= AUx/ADx
X – the number of days;
AU – an average amount of the above-closed prices
for x days;
AD - an average amount of the below-closed prices
for x days;
This oscillator determines the strength of bullish and
bearish moods, tracing the price changes during this period. RSI situates in an
area from 0 to 1 00. The two control
levels (the higher bottom control level is above 70, the lower bottom control
level is below 30) are put on the chart with the help of horizontal markers.
However, some shift of the lines is possible at the strong trend markets: at
the strong bullish markets, they may be at the levels from 40 to 80, at the
strong bearish markets – from 20 – 60. 3 signal types of RSI are known. These
are divergence, chat models and levels.
Bullish divergence gives signals for buying. A bullish
divergence occurs when the prices reach a new low but RSI does not. It
is better to buy when RSI starts rising from this minimum and place a stagnation
point below the level of the last lowest price.
The signal for buying will be
especially strong if the penultimate minimum RSI occurs under the lowest supporting
line and the last minimum above the line. In the case of bearish divergence, we face reversed situation.
Buy signal is strong if the penultimate RSI top is above the top of the supporting line and the last top is
under the supporting line. Among all indicators, classical graphical methods
work better exactly with RSI.
Dynamic of the RSI chat advances prices dynamic for several days giving the material for building suppositions about their further behaviour. Thus, trend line RSI is changing two days before the price.
The rules for analysis of the trend lines RSI are the following: when RSI chat breaks trend line RSI down directed from the bottom place a buy order, in the opposite situation, when RSI chat breaks the trend line RSI up directed place a sell order.
When RSI rises above the top support line we may speak about the bulls’ strength but at the same time, such a situation characterizes the market as overbought and ready for selling. On the contrary, when RSI falls under the bottom support line we speak about the bears’ strength, the market is oversold and in some time traders start to buy.
Holding a long position backed up by overbought signals RSI is reasonable only if there
is a weekly uptrend. One important peculiarity connected with the oscillators
usage should be mentioned.
Any strong trend directed down or up usually makes
oscillators take critical values rather quickly. In such cases it is early to
conclude that the market is overbought or oversold: such a mistake may drive to
the premature closing of the profitable position. For example, during the
uptrend, the market may remain overbought for a long period of time. However, if
the oscillator value is in the top critical position it does not mean that you
should eliminate all deals or open short deal during an uptrend.
The first
appearance of the oscillator value in the overbought or oversold area usually
is just a warning. The more important signal which requires attention is the second
appearance of the curve in the critical area. In case it does not prove the
further rise or fall of the prices and oscillator curve forms double top or
bottom we have to state possible divergence and take certain measures in order
to protect positions.
If a curve turns to the other side and breaks the level
of the previous peak or fall it means that the divergence signal is proved. In such
situations, it is worth using stop orders placing their levels right up close to
the current prices level.
 |
| Pic.7 Indicator chat supported by the strong bullish divergence left overbought area and gave a signal to buy |
Stochastics Oscillator
Developed by George C. Lane 1 950s, the Stochastic Oscillator
is one the most popular oscillators in technical analysis. The oscillator is a
curve fluctuating in the range of 0-1 00.
It is considered that quotations are not stable if the oscillator rises higher than
70 pips or fall below 30 pips.
The stochastic oscillator buy signal is
generated when it moves from below to above 20 per cent and the sell signal is generated
when it moves from above to below 80 per cent. Sometimes simple moving average drew at a chat of the stochastics oscillator.
This is one of the widest
spread methods of technical analysis. With the help of this method price
moving with the selected period is revealed. Two simple moving averages: short
and long are calculated and then the average with the short period is deducted from
the average with the long period.
Formula:
OSC = SMA(P,m) – SMA(P,n)
Actually, this formula shows a cross of moving averages
and that is why this indicator may be rating as oscillator methods, however,
one competent edition ranges it as an oscillator. The authors think that using
this indicator eliminates all short-term prices fluctuations and long-term
trends.
For instance, while trading with one-hour prices’ fluctuations
averaging in one hour is taken as a short period in order not to watch shorter
fluctuations. The time lag of one day may be taken as a long period. Information
about the average level which differs one day from another is lost.
However,
this disadvantage is compensated by the indicator’s visualization. Positive
overrated Oscillator values mean that the price is excessively increased
towards long-term trend and give a signal to buy. High negative values signal to
sell.
Classical Oscillator signals are bullish divergence
and bearish convergence. The cross of the Oscillator of the zero lines from the bottom is a signal to buy if it is a confirmed bullish trend (Oscillator
reverse towards trend dynamics placed below zero lines is considered to be the
earliest signal).
The cross of the Oscillator of the zero lines from the top is
a signal for buying if it is a confirmed bearish trend. The earliest signal is the indicator’s reverse located above the zero lines. This is a trend signal.
Signals against the trend –a reverse of the Oscillator from the overbought and
oversold areas.
This indicator is based on the principle that during an upward
trading market, prices tend to close near their high and during a downward
trading market, price tends to close near their low. Stochastics compares
current closing prices with recent low and high prices on a chart.
The stochastics indicator is plotted as two lines, %K and %D. The second line is
more important and according to its dynamic, we may judge upon the most
significant changes in the market. The %K line is more sensitive than %D.
Mathematically, the %K line looks like this:
%K=1 00*[Ct-L5 / H5-L5]
C = the most recent closing price
L5 = the low of the five previous trading sessions
H5 = the highest price traded during the same 5 day
period.
The formula allows calculating the place of the last
closing price for a certain period of time. If the value is above 70% then the closing price is near the upper bound of the range is it is below 30% then the closing price is near the lower bound.
%D is a 3-period moving average of %K.
The formula for the more important %D line looks
like this:
%D=1 00 * CL3 / HL3
CL3 – three-day sum (Ct-L5);
HL3 – three-day sum (H5-L5).
According to the above formulas two lines are drawn
which fluctuate from 0 to 1 00. Kline is drawn as a continuous line and slower D line – dotted line.
Such stochastic lines are called fast. Some traders
prefer to use slow stochastic lines. In this case formulas for both lines are
changed. %К line is calculated according to the formula for %D, and %D as CC
divided to %K.
Stochastic oscillators show the ability of the bulls or bears
to close the market near the upper or lower range border. If bulls raise prices
during the day but can not close them near-maximum stochastic lines start to
decrease. This gives a signal to buy.
The divergence between the line %D and price which
takes place when the line appears in the oversold or overbought area is a
signal to which you should pay attention. These areas begin beyond the pale of
the horizontal lines, which are determined by lines 70 and 30. The most
important signals for buying or selling occur when the line В is in the area
from 1 0 to 1 5
and from 85 to 90. Stochastic gives the signal of three types:
1. The strongest signals for buying or selling occur
when the divergence takes place between the prices and indicators. Bullish
divergence appears when line %D is above 70 and forms two falling tops and
prices continue to rise.
The line %D is under 30 and forms double upward bottom
and prices continue to fall when we have bearish divergence. In case of the existence of all these factors the final signal (to buy or to sell) is
registered when Kline crosses the %D line – after the last one has already changed
its moving direction.
In other words, the intersection should be on the right of
the line %D extreme point. Thus, the signal to buy is more important in the
bottom area, if the line K during its rise crosses the line %D after the line
%D has already turned upwards.
The signal to buy is more significant in the top
area if the line %D reverses and starts moving downwards before K crosses it.
The importance of intersection is higher if both lines move in one direction.
2. Another signal is when an indicator occurs in the
oversold or overbought area. If we have a weekly bullish trend and daily
stochastic lines fall below the bottom line make a buy order establishing a protective stop at the level of the previous button.
For the opposite situation
make an order to sell. Stochastic lines extreme form very often allows judging
about the possible rise strength. In the case of the narrow minimum, the bear's
strength is low and we may expect a strong rise.
Opposite conclusions may be done
in case the minimum is wide and deep. The same conclusions may be done
regarding maximums of the stochastic lines.
3. The next signal is the direction of the price chat and
stochastic line ratio. Stochastic confirms short-term trends when both its
lines have the same direction. Most probably that the upward trend will
continue if both prices and stochastic rise. If the prices are moving and both
stochastic lines rise short-term trend will very likely continue.
 |
| Pic.8 Pay attention to how reliable stochastic indicates signals to buy for pair USD/RUR. The intersection of line %D by line %К and further moving downwards from the overbought area give perfect signals to buy (work only in the trend direction). |
Helpful information for the users of the InstaTrader terminal
A number of indicators of the technical analysis
are used by the program:
Average Directional Movement
One of the most frequently
used technical indicators which allow determining trend (the tendency of the price
change). J. Welles
Wilder pays a lot of attention
to this indicator in his book “New Concepts In Technical Trading
Systems”.
Bollinger Bands
Bollinger Bands are an indicator that allows users
to compare volatility
and relative price levels over a period of time. A band plotted two standard
deviations away from a simple moving average. Because standard deviation is a
measure of volatility, Bollinger bands adjust themselves to the market
conditions.
When the markets become more volatile, the bands widen (move
further away from the average), and during less volatile periods, the band's
contract (move closer to the average). The tightening of the bands is often
used by technical traders as an early indication that the volatility is about
to increase sharply.
This is one of the most popular technical analysis
techniques. The closer the prices move to the upper band, the more overbought
the market, and the closer the prices move to the lower band, the more oversold
the market.
Commodity Channel Index
This technical indicator is used for measuring
price deviations of the financial asset from the average value. If the index value
is high, a price is considered to be overstated; if the index value is low, a price
is considered to be understated.
DeMarker
It shows the difference between the current and the previous bar – if the maximum of the previous bar is higher the difference is
registered, if the maximum of the previous bar is lower or equal to the current
maximum the difference remains zero. The DeMarker indicator fluctuates from 0
up to 1 00.
The turn of the prices
downwards is expected if the parameter of the indicator moves above a mark of 70.
The turn of the prices upwards is expected if the indicator moves below a mark
30.
Envelope
This indicator of the technical analysis is formed
by the two lines of the moving averages, one is shifted upwards, another
downwards. Moving Average Envelopes serve as an indicator of overbought or oversold
conditions, visual representations of price trend, and an indicator of price
breakouts.
Moving Average
Moving averages are one of the most popular and
easy to use tools available to the technical analyst. Calculation of the moving
average is made with a certain selected period. The more value of the period
the least is the possibility of the false signals and sensitiveness of the
moving average.
MACD (Moving Average Convergence Divergence)
A trend-following momentum indicator that
shows the relationship between two moving averages of prices. The MACD
is calculated by subtracting the 26-day exponential moving
average (EMA) from the 1 2-day
EMA. A nine-day EMA of the MACD called the "signal line", is
then plotted on top of the MACD, functioning as a trigger for buy and sell
signals.
Momentum
This is a technical indicator that is designed to
identify the speed (or strength) of a price movement. Usually, the momentum
indicator compares the most recent closing price to a previous closing price,
but it can also be used on other indicators such as moving averages.
Oscillator
The oscillator is calculated as the difference of the moving averages with the long
and short periods.
Parabolic SAR
An indicator is built on the price chat. By
implication, this indicator is an analogue of the moving average, but PSAR moves
with the greater acceleration and is able to change its position relative to the
price. If a price crosses PSAR lines indicator’s turn takes place and the next
values of the indicator are placing opposite the price. Maximal or minimal price
for the previous period will serve as the reference point. An indicator’s turn is
a signal which indicates that a trend either stops or reverses.
Rate of Change (ROC)
The Rate of Change (ROC) indicator
is a very simple yet effective momentum oscillator that measures the per cent change in price from one period to the next. The ROC
calculation compares the current price with the price n periods ago. Intervals
from a minute to a month may be taken as periods.
Relative Strength Index
Indicator RSI is an
indicator of the price change speed. This indicator is characterized by the
price change for a certain period of time, it shows the strength of the price.
It calculates the average values of the price increase and decreases.
Standard Deviation
An indicator shows the strength of the price
variability for a certain period of time. Standard deviation is calculated
according to the simple formula: it is the square root of the variance.
Stochastic Oscillator
Stochastic Oscillator compares a current price with the price range for a certain period. The indicator is represented by two lines.
William's Percent
Range
Williams’ Percent Range Technical Indicator (%R) is
a dynamic technical indicator, which determines whether the market is
overbought/oversold. It has an upside downscale.
For the most exacting technical analysis users the
opportunity to export data for further analysis is foreseen in the specialized
systems of the technical analysis Omega Tradestation and Metastock.
Lessons:
- Operations With Trader Platform On The Basis Of Meta Trader 4
- Mathematical Analysis