Technical Indicators
Lesson 1
Moving Averages
The moving average (MA) is one of the most popular and widely used technical indicators in the financial markets. It smoothens price data to create a single flowing line, which makes it easier for traders to identify the direction of the trend.
Definition:
A moving average simply averages a set of data points over a specific number of periods. The “moving” part of the name stems from the fact that as new data points become available, the oldest data points are dropped, and the average “moves” over time.
There are 2 types of moving averages
Simple Moving Average (SMA): It calculates the average of a selected range of prices, usually closing prices, by the number of periods in that range.
Formula: SMA = (Sum of Prices over n periods) / nFor instance, a 10-day SMA would add up the closing prices from the last 10 days and divide by 10.
Exponential Moving Average (EMA): It places a greater weight and significance on the most recent data points. The weighting applied to the most recent price depends on the specified period of the EMA.
Formula: EMA_today = (Close – EMA_yesterday) x Multiplier + EMA_yesterday Where, Multiplier = 2 / (Number of periods + 1)
What It Shows:
Trend Direction: If the moving average is rising, this indicates that the asset’s price is in an uptrend. Conversely, if the moving average is declining, this could suggest a potential downtrend.
Support and Resistance Levels: Prices often respect moving averages in a way that they may bounce off them. This makes moving averages potential dynamic support or resistance levels.
Price Crossovers: When an asset’s price crosses above or below a moving average, it may signal a potential change in trend direction.
How to Trade Moving Averages
Crossover Strategy:
Golden Cross: When a short-term moving average crosses above a long-term moving average, it may indicate a bullish signal. For example, when the 50-day SMA crosses above the 200-day SMA, it can be viewed as a bullish “Golden Cross.”
Death Cross: The opposite of the Golden Cross. When a short-term moving average crosses below a long-term moving average, it suggests a bearish trend. An example is when the 50-day SMA crosses below the 200-day SMA.
Price Touches:
Support in Uptrends: When the price of an asset is in an uptrend and retraces back to touch a rising moving average, traders might look for buy opportunities expecting the trend to continue.
Resistance in Downtrends: Conversely, if the price is in a downtrend and rallies to touch a declining moving average, it might act as resistance and traders may look for selling opportunities.
Moving Average Envelopes:
Moving average envelopes are percentage-based envelopes set above and below a moving average. The type of moving average used with the envelopes doesn’t matter, so traders can use a simple, weighted, or exponential MA. These envelopes can act as potential areas of support and resistance.
Example: A 50-day moving average with a 5% envelope would produce bands 5% above and 5% below the 50-day moving average.
Caution: Like all technical indicators, the moving average has its limitations. It’s imperative to use it in conjunction with other tools and analysis methods to confirm signals and make well-informed decisions.
An example of the moving averages
Lesson 2
On Balance Volume (OBV)
The OBV, or On-Balance Volume, is a technical indicator used in the realm of financial trading, primarily for stocks and forex. Joe Granville introduced it in his 1963 book “New Key to Stock Market Profits.”
It offers traders insights into the flow of volume in relation to price changes, aiming to show when assets are being accumulated or distributed. The main premise behind OBV is that volume can indicate strong moves in price before they occur.
What it is and what it shows
OBV is a cumulative indicator. At its core, it keeps a running total of volume and adjusts this total based on whether prices move up or down.
Here’s a simple breakdown:
If today’s closing price is higher than yesterday’s closing price, then
OBV = Previous OBV + Today’s Volume
If today’s closing price is lower than yesterday’s closing price, then:
OBV = Previous OBV – Today’s Volume
If today’s closing price is equal to yesterday’s closing price, then:
OBV remains the same.
The basic idea is that when volume is increasing in the direction of the trend, it confirms the trend. For instance, if the price is going up and the OBV is going up as well, this is a bullish sign. Conversely, if the price is going down and OBV is decreasing, this is bearish.
How to trade it
The OBV can be used in multiple ways for trading:
Trend Confirmation: As previously mentioned, if the price and OBV are moving in the same direction, it confirms the strength of the trend. If they diverge (e.g., prices go up but OBV goes down), it could be a sign that the trend is weakening and might reverse.
Example: If a stock is rising but OBV starts to plateau or decrease, this could be an early sign that upward momentum is waning and a potential reversal or pullback might be near.
Bullish and Bearish Divergences: These are potent signals provided by OBV. A divergence occurs when the price is making new highs/lows, but the OBV isn’t.
Example: If a stock makes a new high but the OBV doesn’t surpass its previous high, it’s a bearish divergence. Conversely, if a stock makes a new low but the OBV doesn’t make a new low, that’s a bullish divergence. These divergences can indicate a potential price reversal.
Breakouts and Breakdowns: OBV can help validate breakouts or breakdowns. For instance, if a stock price breaks above a resistance level and the OBV is also trending up, it’s more likely a genuine breakout.
Example: A stock breaks out of a consolidating pattern (like a triangle). If the OBV also shows a strong upward move, traders may consider this a valid breakout and anticipate further price appreciation.
An example of an OBV
Lesson 3
Relative Strength Index (RSI)
The RSI, or Relative Strength Index, is a momentum oscillator introduced by J. Welles Wilder in his 1978 book “New Concepts in Technical Trading Systems.” This technical indicator measures the speed and change of price movements, oscillating between zero and 100. It is commonly used to identify overbought or oversold conditions in a traded security.
What it is and what it shows
The RSI calculates the relative strength of a security’s price performance, aiming to identify conditions where it might be overextended, either to the upside (overbought) or downside (oversold).
Here’s how the RSI is calculated:
RSI = 100 – (100 / (1 + RS))Where: RS = Average of ‘n’ days’ up closes / Average of ‘n’ days’ down closes Typically, ‘n’ is set to 14 periods, which can be days, weeks, months, or even an intraday timeframe.
The resulting number will range between 0 and 100. Generally:
An RSI above 70 suggests that a security might be overbought and could be primed for a price pullback or correction.
An RSI below 30 suggests that a security might be oversold and could be ripe for a price bounce or recovery.
How to trade it
The RSI is versatile and can be used in various trading strategies:
Overbought and Oversold: The most basic and common way to use the RSI is to identify potential buy or sell opportunities when a security becomes overbought (RSI above 70) or oversold (RSI below 30). However, just because a security is in overbought territory doesn’t mean it will reverse immediately, and the same goes for oversold conditions.
Example: If a stock has an RSI reading of 78, some traders might consider it overbought and anticipate a potential pullback.
Divergences: Divergences between RSI and price action can be strong signals. Bullish divergence occurs when the price makes a new low, but the RSI makes a higher low. This might indicate an upcoming upward reversal. Conversely, bearish divergence occurs when the price makes a new high, but the RSI makes a lower high, indicating potential downside.
Example: If a stock makes a lower low, but RSI forms a higher low, it could suggest weakening downward momentum and a potential reversal to the upside.
RSI Trendlines and Breakouts: Similar to price charts, traders can draw trendlines on the RSI chart. Breakouts or breakdowns from these trendlines can be used as potential trade signals.
Example: If the RSI is trending down and breaks above a descending trendline, it might indicate a shift in momentum and a potential buy signal.
Centerline Crossover: When the RSI crosses above the 50 level, it can be considered a bullish signal, and when it crosses below, a bearish signal. This can be an indication of a shift in the overall trend.
Example: If a stock’s RSI moves from 45 to 55, it crossed the centerline, suggesting increasing bullish momentum.
An example of the RSI
Lesson 4
Stochastic Oscillator
The Stochastic Oscillator is a momentum indicator that was developed by George C. Lane in the late 1950s. It compares a particular closing price of a security to a range of its prices over a certain period of time. The oscillator’s sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result.
What it is and what it shows
The Stochastic Oscillator provides readings that show the position of the current closing price relative to the high-low range over a defined number of periods.
The formula for the Stochastic Oscillator is as follows:
%K = [(Current Close – Lowest Low) / (Highest High – Lowest Low)] x 100
%D = 3-day SMA of %K
Usually, the Stochastic Oscillator is plotted as two lines:
%K which is often referred to as the fast line
%D which is a moving average of %K and can be termed as the slow line
When the Stochastic Oscillator has values above 80, it’s usually perceived as an overbought indication. On the flip side, a value below 20 might be seen as oversold. However, these thresholds can vary based on the asset’s inherent characteristics.
How to trade it
The Stochastic Oscillator offers multiple ways for traders to interpret its readings:
Overbought and Oversold: When the Stochastic Oscillator exceeds 80, it can be seen as an indication that the security might be in an overbought condition. Conversely, a reading below 20 may indicate the asset is potentially oversold. It’s important to remember that just because the Stochastic Oscillator enters overbought or oversold areas, it doesn’t mean a reversal will occur immediately.
Example: If a forex pair has a reading of 85 on the Stochastic Oscillator, some traders might anticipate a potential bearish reversal, especially if other indicators confirm this sentiment.
Bullish and Bearish Divergences: These occur when the price action of a security differs from the movement of the Stochastic Oscillator. A bullish divergence is formed when the security records a lower low, but the Stochastic Oscillator forms a higher low. Conversely, a bearish divergence forms when the security records a higher high, but the oscillator forms a lower high.
Example: If a stock’s price creates a new low while the Stochastic Oscillator doesn’t reach its previous low, this could indicate decreasing downward momentum and a potential bullish reversal.
Stochastic Crossovers: A crossover is one of the primary trading signals of the Stochastic Oscillator. A bullish crossover occurs when the %K value crosses above the %D line, signaling potential upward momentum. A bearish crossover occurs when the %K value drops below the %D line, indicating potential downward momentum.
Example: If the %K line (fast line) crosses above the %D line (slow line) and both lines are below 20, it might be considered a bullish signal by some traders.
As always, it’s essential to utilize the Stochastic Oscillator in combination with other technical tools and analysis techniques. This ensures a more holistic view of the market and better-informed trading decisions.
An example of the Stochastic Oscillator
Lesson 5
Bollinger Bands
The Bollinger Bands were developed by John Bollinger in the 1980s as a tool to help traders identify potential price volatility and relative high or low prices in relation to previous trades. These bands provide a relative definition of high and low prices and can be used to identify potential overbought or oversold conditions.
What it is and what it shows
Bollinger Bands consist of three lines:
Middle Band – A simple moving average (typically a 20-period SMA)
Upper Band – Middle band + (multiplier x standard deviation)
Lower Band – Middle band – (multiplier x standard deviation)
Standard settings involve a 20-day period with a 2 standard deviation multiplier, but these can be adjusted based on the asset and timeframe being traded.
The key features of Bollinger Bands are the spacing between the bands and their relative position to the current price. When the bands contract, it can indicate a period of low volatility, often referred to as the “squeeze.” When they expand, it suggests increased volatility.
How to trade it
There are several strategies and signals that traders use with Bollinger Bands:
Bollinger Bounce: One of the most common strategies is the ‘Bollinger Bounce’, which capitalizes on the nature of the bands to act as support and resistance levels. Prices tend to bounce back from the outer bands.
Example: If a stock’s price touches the lower band and begins to turn upward, traders might consider it as a buying opportunity, expecting the price to bounce back toward the middle band.
Bollinger Squeeze: A squeeze denotes a period of low volatility and is considered by traders as a potential indicator of future increased volatility and possible trading opportunities.
Example: If the bands squeeze together tightly, it could be an indication that a breakout, either upward or downward, might be imminent.
Riding the Bands: In a strong uptrend, price might ride the upper band, and during a downtrend, it might ride the lower band. This can be a signal that the current trend is strong and might continue.
Example: If a currency pair in a forex market is riding the upper Bollinger Band and the indicators are showing the pair is not overbought, a trader might stay long, expecting the pair to continue its upward momentum.
Bollinger Band Breakouts: Traders might buy or sell securities when the price breaks and closes outside of the bands.
Example: If a stock’s price closes above the upper Bollinger Band, some traders might view this as a sign to sell, anticipating a pullback toward the middle band. Conversely, a close below the lower band might prompt a buy order.
When utilizing Bollinger Bands, it’s always recommended to use them in conjunction with other technical indicators or methods to confirm signals and make more informed trading decisions.
An example of the Bollinger Bands
Lesson 6
Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence, commonly known as MACD, is a trend-following momentum indicator that reveals the relationship between two moving averages of an asset’s price. Gerald Appel introduced it in the late 1970s, and since then, it has become one of the most widely used indicators in technical analysis.
What it is and what it shows
MACD is computed by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The result of that calculation creates the MACD line. A 9-day EMA of the MACD, called the “signal line,” is then plotted on top of the MACD line, which can act as a trigger for buy and sell signals.
MACD indicators typically have a histogram. The histogram shows the difference between the MACD line and the signal line. When the MACD is above its signal line, the histogram will be above the MACD’s baseline (positive). Conversely, when the MACD is below its signal line, the histogram will be below the MACD’s baseline (negative).
In essence, MACD does the following:
Indicates momentum: The closer MACD moves to zero line, the closer the 12-period and 26-period EMAs are.
Shows trend direction: When the MACD is above zero, the short-term average is above the long-term average, indicating upward momentum. Conversely, when it’s below zero, it indicates downward momentum.
Identifies duration of momentum: If MACD is far away from the zero line, momentum is high. When it’s close, momentum is low.
How to trade it
There are various ways traders use MACD for making trading decisions:
Crossovers: This is the most common MACD signal. A bullish crossover occurs when the MACD line crosses above the signal line. A bearish crossover happens when the MACD line crosses below the signal line. Crossovers can be used as a buy or sell signal.
Example: If MACD crosses above the signal line, some traders might consider buying the asset. If it crosses below, they might consider selling.
Overbought/Oversold Conditions: Even though MACD isn’t bound to an upper or lower limit, traders often use it to identify overextended price moves. If MACD has risen significantly and is well above zero, the asset might be overbought. Conversely, a significant drop below zero can indicate an oversold condition.
Divergence: When the asset’s price diverges from MACD, it can be an end-of-trend warning. A bullish divergence forms when the asset records a lower low, but the MACD forms a higher low. This can suggest less downward momentum. A bearish divergence is the opposite, indicating weakening upward momentum.
Example: If a stock’s price makes a new high, but MACD doesn’t reach its previous high, this could be a sign of potential bearish reversal.
Zero-Line Crossovers: MACD’s zero line often acts as a support and resistance level. A bullish centerline crossover occurs when MACD moves above zero and into positive territory. This signals that the 12-day EMA has crossed above the 26-day EMA. A bearish centerline crossover occurs when MACD moves below zero.
It’s crucial to remember that while MACD can be a potent tool, no indicator is foolproof. It’s always recommended to combine MACD with other forms of technical analysis to make well-informed trading decisions.
An example of the Bollinger Bands
Lesson 7
Fibonacci Retracement
Fibonacci retracement is a popular tool among technical traders, utilized to identify potential support and resistance levels. Based on the Fibonacci sequence—a series of numbers where each number is the sum of the two preceding ones—this tool draws horizontal lines to indicate where potential price reversals could occur.
What it is and what it shows
Fibonacci retracement levels are horizontal lines that indicate potential support or resistance levels based on the Fibonacci sequence. By drawing a line from a significant peak to a trough (or vice versa), these levels are generated at key Fibonacci levels, commonly 23.6%, 38.2%, 50%, 61.8%, and sometimes 78.6%.
The foundational idea behind Fibonacci retracement is that markets will retrace a predictable portion of a move before continuing in the original direction. These retracements provide traders with potential levels to enter trades or place stops.
To understand why these particular percentages matter, it’s worth noting that the Fibonacci sequence has certain mathematical properties. For instance, the ratio of a number to the next higher number is approximately 0.618, hence the 61.8% retracement level. Similarly, the inverse of 0.618 is 1.618, which gives rise to other levels.
How to trade it
Trading with Fibonacci retracement involves several strategies:
Identifying Potential Support and Resistance: One primary use is to identify potential support and resistance levels. When a price decline is expected to end, it might do so near a Fibonacci retracement level (e.g., 61.8%). Conversely, during an uptrend, the price might find resistance near one of these levels.
Example: If a stock rises from $10 to $15 and then starts to decrease, the 50% retracement level of that move is $12.50. Some traders might see this as a potential support level.
Setting Stop Loss Orders: Traders can set their stop loss orders at or near Fibonacci retracement levels. If a trader believes the price will find support at a retracement level, they might place their stop loss just below that level.
Example: If a trader enters a long position near the 38.2% retracement level, they might set a stop loss just below the 50% retracement to protect their position.
Target Setting: Retracement levels can also be used to set price targets. For instance, if a price bounces off a retracement level, the next higher retracement can be used as a potential target.
Example: If price finds support at the 50% retracement level and starts moving up, the 38.2% level above might serve as a potential short-term target.
Combination with Other Tools: It’s always a good idea to combine Fibonacci retracement with other technical analysis tools such as trendlines, moving averages, and other indicators to increase the likelihood of making successful trades.
Traders should remember that while Fibonacci retracement can provide valuable insights, no tool guarantees success in the markets. It’s always essential to apply risk management practices and continuous research when making trading decisions.
An example of the Fibonacci Retracement
Lesson 8
Ichimoku Cloud
The Ichimoku Cloud, with its origins in Japan, is an all-in-one technical analysis tool that captures an asset’s trend, momentum, and support/resistance levels. Introduced by Goichi Hosoda in the 1960s, it provides traders with a comprehensive overview of the market conditions at a single glance.
What it is and what it shows
The Ichimoku Cloud is comprised of five main components, each serving a unique purpose in assessing the market conditions:
Tenkan-sen (Conversion Line): This is calculated by taking the average of the highest high and the lowest low over the past 9 periods. It can represent a short-term momentum and key areas of support or resistance.
Kijun-sen (Base Line): Calculated by averaging the highest high and the lowest low over the past 26 periods. It offers a longer-term momentum indicator and is a major signal line.
Senkou Span A (Leading Span A): This is the average of the Tenkan-sen and the Kijun-sen, plotted 26 periods ahead. It forms one edge of the Ichimoku Cloud.
Senkou Span B (Leading Span B): Calculated by averaging the highest high and the lowest low for the past 52 periods, then plotted 26 periods ahead. It forms the other edge of the Ichimoku Cloud.
Chikou Span (Lagging Span): This is the most recent closing price plotted 26 periods back. It serves as a momentum indicator.
The space between Senkou Span A and Senkou Span B is shaded and known as the ‘Cloud’ or ‘Kumo’. The cloud serves as a visual representation of support and resistance levels. A cloud where Senkou Span A is above Senkou Span B is typically shaded green, indicating bullish sentiment, whereas the opposite is shaded red, indicating bearish sentiment.
How to trade it
Trading with the Ichimoku Cloud involves understanding its components and the relationships between them:
Price and Cloud Interaction: The position of the price concerning the cloud can provide trend insights. If the price is above the cloud, it indicates an uptrend; below the cloud suggests a downtrend. When the price is inside the cloud, the market may be in a consolidation phase or trend transition.
Example: If a stock’s price moves from below the cloud to above, it might signify a potential start of an uptrend.
Tenkan-sen and Kijun-sen Crossovers: Similar to moving average crossovers, when the Tenkan-sen crosses above the Kijun-sen, it can be seen as a bullish signal. Conversely, a bearish signal is given when the Tenkan-sen crosses below the Kijun-sen.
Example: If the Tenkan-sen line crosses above the Kijun-sen line while both are below the cloud, it might be a buying opportunity, especially if other indicators are also bullish.
Cloud Twists: When Senkou Span A crosses Senkou Span B, it’s known as a “twist” and can be an indication of a potential trend reversal.
Chikou Span Confirmations: The position of the Chikou Span concerning the price 26 periods ago can offer confirmation of other Ichimoku signals. If the Chikou Span is above the price, it confirms bullish signals; below the price confirms bearish signals.
Support and Resistance: The cloud itself can serve as an area of support or resistance. In an uptrend, the cloud can act as a support level, and in a downtrend, it can act as resistance.
While the Ichimoku Cloud offers a plethora of information at a glance, traders should always use it in conjunction with other indicators and tools for confirmation and enhanced accuracy.
An example of the Ichimoku Cloud
Lesson 9
Parabolic SAR
The Parabolic SAR (Stop and Reverse) is a popular technical analysis indicator developed by J. Welles Wilder. It’s designed to provide potential entry and exit points, and to signal the direction of a trend. The indicator is called “parabolic” because, when plotted on a chart, the dots representing the SAR form a parabolic shape.
Calculating the Parabolic SAR
The Parabolic SAR is calculated using the following formulas:
Uptrend: SAR = Prior SAR + Prior AF(Prior EP – Prior SAR)
Downtrend: SAR = Prior SAR – Prior AF(Prior SAR – Prior EP)
Where:
SAR = Stop and Reverse
AF = Acceleration Factor, which starts at 0.02 and increases by 0.02 each time a new extreme point (EP) is recorded, up to a maximum of 0.20.
EP = Extreme Point, which is the highest high in an uptrend or the lowest low in a downtrend.
Interpreting the Parabolic SAR
The Parabolic SAR is plotted as a series of dots above or below the price bars. When the dots are below the price bars, this suggests an uptrend and is a signal to buy or hold. When the dots are above the price bars, this suggests a downtrend and is a signal to sell or short.
The Parabolic SAR is also used to set trailing stop losses. In an uptrend, the SAR value can be used as a stop loss level that moves up as the price rises. In a downtrend, the SAR value can be used as a stop loss level that moves down as the price falls.
Trading with the Parabolic SAR
The Parabolic SAR can be a useful tool for traders looking to identify potential entry and exit points. Here are a few ways it can be used:
Trend Identification: If the Parabolic SAR dots are below the price, this indicates an uptrend. If they’re above the price, this indicates a downtrend.
Entry Points: A trader might consider entering a long position when the Parabolic SAR moves below the price (indicating an uptrend) and entering a short position when the Parabolic SAR moves above the price (indicating a downtrend).
Exit Points: A trader might consider exiting a long position when the Parabolic SAR moves above the price (indicating a potential downtrend) and exiting a short position when the Parabolic SAR moves below the price (indicating a potential uptrend).
Stop Loss Levels: The Parabolic SAR can be used to set a trailing stop loss. In an uptrend, the stop loss can be set at the level of the Parabolic SAR dot below the price. In a downtrend, the stop loss can be set at the level of the Parabolic SAR dot above the price.
An example of the Parabolic SAR
In Conclusion the Parabolic SAR is a versatile and popular technical analysis indicator that can help traders identify the direction of a trend, potential entry and exit points, and appropriate stop loss levels. However, like all technical indicators, it’s not foolproof and should be used in conjunction with other tools and analysis techniques.
Always remember to consider your own risk tolerance and trading goals when using the Parabolic SAR or any other technical indicator.
Lesson 10
Average True Range Indicator
The Average True Range (ATR) is a technical analysis indicator introduced by J. Welles Wilder in his 1978 book “New Concepts in Technical Trading Systems.” Designed primarily as a tool to measure market volatility, the ATR offers insights into the historical price movement of a security, independent of its price direction.
What it is and what it shows
The ATR calculates the true range for a given period, which is the greatest of the following:
Current high minus the current low
Absolute value of the current high minus the previous close
Absolute value of the current low minus the previous close
The ATR itself is the moving average of the true ranges over a specified period, typically 14 days.
It’s essential to understand that the ATR doesn’t provide any indication regarding price direction. Instead, it focuses solely on price volatility. A higher ATR suggests that the price of the security has seen significant price moves in a short amount of time, implying a more volatile market. Conversely, a lower ATR indicates less volatility.
How to trade it
The ATR serves various purposes in trading:
Setting Stop Losses: One of the most common uses of ATR in trading strategies is to determine stop-loss levels. A trader might set a stop loss at a multiple of the current ATR value away from the entry price. For example, if a stock is purchased at $50 and the ATR is $2, a trader might place a stop-loss order at $46 (2 x ATR below the purchase price).
Position Sizing: ATR can also assist in determining position size. If a trader decides they’re willing to risk a certain amount per share, the ATR can help dictate how many shares to buy.
Breakout Trades: A rising ATR in conjunction with a price breakout can be a sign of the start of a significant trend. For instance, if a stock breaks above a key resistance level and the ATR is rising, it might signify strong buying interest and a powerful upward move.
Filtering Out Noise: In less volatile markets, minor price fluctuations can be misleading. Using ATR can help traders distinguish between genuine trend shifts and minor price noise.
Volatility-based Trading Systems: Some traders design entire systems around volatility, using the ATR as a key component. For example, a system might go long when prices are above a moving average and the ATR is rising, indicating increasing volatility in an upward trend.
An example of the ATR
In conclusion, while the Average True Range doesn’t provide directional clues, it offers invaluable insights into market volatility. This understanding can be instrumental in creating robust trading strategies that account for the inherent risks associated with price movements. Properly used, the ATR can help traders place smarter stop losses, size positions appropriately, and detect genuine trend breakouts.
Lesson 11
Money Flow Index
The Money Flow Index (MFI) is a technical oscillator that measures the inflow and outflow of money into a security over a specific period. Conceptually similar to the Relative Strength Index (RSI), the MFI also operates on a scale of 0 to 100. However, while RSI focuses on price changes, MFI incorporates volume, thereby providing a more comprehensive view of buying and selling pressure.
What it is and what it shows
MFI is calculated using the typical price for each period and the volume for that period. The idea is to ascertain how much conviction there is in each price move; high volume moves are given more weight than low volume moves.
To compute the MFI:
Calculate the Typical Price: Typical Price= (High+Low+Close)/3
Calculate the Money Flow: Money Flow=Typical Price × VolumeMoney
Accumulate Positive and Negative Money Flow: If today’s typical price is greater than yesterday’s, it’s considered positive money flow. If it’s less, it’s negative money flow.
Calculate the Money Flow Ratio: Money Flow Ratio = Positive Money Flow Over ‘n’ Days / Negative Money Flow Over ‘n’ Days
Compute the MFI: MFI = 100 − (100/(1+Money Flow Ratio))
In terms of its readings:
An MFI above 80 is considered overbought, indicating that the security might be in a state of overvaluation.
An MFI below 20 is considered oversold, signaling a potential undervaluation of the security.
How to trade it
MFI offers various potential strategies for traders:
Overbought/Oversold Conditions: An MFI reading over 80 suggests that the security may be overbought and might be ripe for a sell-off. Conversely, an MFI below 20 can indicate that the security may be oversold and could be a buying opportunity.
Example: A stock with an MFI reading of 85 might be an indication to consider taking profits if one holds a long position.
Divergences: Divergence between MFI and price action can provide strong reversal signals. If the security is making new highs but the MFI is declining, it indicates weakening momentum and potential bearish reversal. Similarly, if a security is making new lows while the MFI is rising, it could indicate potential bullish reversal.
Example: A stock makes a new price high, but the MFI fails to make a new high, suggesting a potential trend reversal.
MFI and Support/Resistance: MFI can be used in conjunction with support and resistance levels. For instance, if a stock bounces off a known support level and MFI turns up from an oversold level, it might provide a more robust buy signal.
Example: A stock approaches a known support level with an MFI reading of 18. If the stock starts to rebound and the MFI starts to ascend, it could be a bullish sign.
Trend Confirmations: In a strongly trending market, MFI can serve as a confirmation tool. If a stock is in an uptrend and MFI remains above 50, it confirms the strength of the trend.
An example of the MFI
In conclusion, the Money Flow Index is a powerful tool that incorporates both price and volume to offer traders insights into buying and selling pressure. Like all indicators, it’s essential to use MFI in conjunction with other tools and analysis techniques to refine trade signals and manage risk.
Lesson 12
De-trended Price Oscillator
The De-trended Price Oscillator (DPO) is a momentum oscillator that eliminates the trend influence from an asset’s price. By doing this, the DPO provides a clear view of the price oscillations around a zero baseline, aiming to identify cycles more effectively.
What it is and what it shows
The DPO is unique because it does not align with the latest prices. It is shifted back in time to center its charting display. The primary purpose of DPO is to highlight the underlying cycles in the price action of an asset.
The formula to calculate DPO is:
Determine the period you wish to study (commonly 20 periods).
Calculate the displaced moving average: Simple Moving Average of chosen periods but displaced back by (period/2 + 1) days.
DPO = Closing price – Displaced moving average.
A positive DPO indicates that the price is above the displaced moving average and vice versa.
How to trade it
Zero Line Crossovers:
Buy when the DPO crosses above the zero line, indicating potential upward momentum.
Sell when the DPO crosses below the zero line, indicating potential downward momentum.
Example: If an asset’s DPO moves from -2 to 1, crossing the zero line, it can be taken as a bullish signal.
Overbought and Oversold:
Though DPO doesn’t have fixed overbought or oversold levels, traders can establish these based on historical levels where reversals occurred.
Example: If historically, an asset reverses after reaching a DPO of 5, a trader can use that as an overbought level.
Divergences:
Bullish divergence: When the asset’s price makes lower lows, but the DPO makes higher lows.
Bearish divergence: When the asset’s price makes higher highs, but the DPO makes lower highs.
Example: If an asset forms a new low, but the DPO forms a higher low, it suggests potential bullish momentum.
Limitations Of The DPO
Not Suited for Trend Identification: By design, the DPO removes trends, so it isn’t effective for identifying long-term trends.
Lagging Indicator: DPO is based on past prices, so it may not react swiftly to recent price changes.
No Fixed Overbought/Oversold Levels: Unlike indicators like RSI, the DPO doesn’t have standardized overbought/oversold levels, which can make interpretation subjective.
An example of the DPO
In Conclusion the De-trended Price Oscillator offers a unique perspective on price cycles by removing the overarching trend influence. While effective in highlighting short-term cycles, traders should use it in conjunction with other tools and indicators to validate its signals. Always consider the inherent limitations of any indicator and ensure risk management practices are in place.
Lesson 13
Rate Of Change Indicator
The Rate Of Change (ROC) is a momentum-based technical indicator that measures the percentage change in price from one period to another. By doing this, the ROC offers insights into the speed of a security’s price movement.
What it is and what it shows
The ROC is calculated by taking the difference between the current price and the price a certain number of periods ago, divided by the price a certain number of periods ago. The result is multiplied by 100 to provide a percentage.
Formula:
ROC = [(Current Price – Price n periods ago) / (Price n periods ago)] * 100
For example, if the current price of a stock is $110 and its price 10 days ago was $100, the ROC would be:
ROC = [(110 – 100) / 100] * 100 = 10%
This indicates that the stock’s price has increased by 10% over the 10-day period.
How to trade it
Zero Line Crossovers:
Buy when the ROC crosses above the zero line, indicating potential upward momentum.Sell or go short when the ROC crosses below the zero line, indicating potential downward momentum.Example: If an asset’s ROC moves from -2% to 3%, crossing the zero line, it can be taken as a bullish signal.
Divergences:
Bullish divergence: When the asset’s price makes lower lows, but the ROC makes higher lows.Bearish divergence: When the asset’s price makes higher highs, but the ROC makes lower highs.Example: If an asset’s price forms a new low, but the ROC forms a higher low, it suggests weakening downward momentum.
Overbought/Oversold:
While the ROC doesn’t have fixed levels for overbought or oversold conditions, traders can establish these based on historical observations of where the ROC typically reverses.Example: If the ROC reaches a level it hasn’t reached in a long time, it might indicate an extreme and a potential price reversal.
Limitations Of The ROC
Volatility: ROC can be very volatile, especially with volatile assets, leading to potential false signals.
No Trend Insights: ROC focuses on momentum and doesn’t offer insights into the direction of the longer-term trend.
Subjectivity: The absence of standardized overbought/oversold levels can make interpretation subjective.
An example of the ROC
In Conclusion The Rate Of Change indicator offers a clear perspective on the momentum of an asset by measuring the speed of its price movement as a percentage. When used in conjunction with other technical tools and a proper risk management strategy, the ROC can be a valuable addition to a trader’s toolkit. However, it’s vital to be aware of its limitations and ensure that trading decisions are based on a holistic analysis rather than relying solely on one indicator.
Lesson 14
Leading and Lagging Indicators
In the realm of technical analysis and market forecasting, indicators play a pivotal role in helping traders and analysts gauge market direction, momentum, volatility, and other aspects. These indicators can broadly be classified into two categories: Leading and Lagging Indicators. Understanding the distinction between the two is crucial for effective market analysis and trade decision-making.
Choosing Between Leading and Lagging Indicators
Trading Style: Short-term traders might prefer leading indicators for early signals, while long-term traders might opt for lagging indicators for trend confirmation.
Risk Appetite: Those with a higher tolerance for risk might be more comfortable with the potential false signals from leading indicators. Conversely, risk-averse traders might prefer the reliability of lagging indicators.
Combining Indicators: It’s common practice to use a mix of both leading and lagging indicators to balance early signals with confirmation.
Leading Indicators
Leading indicators are designed to anticipate and predict future movements in the price of a security. They signal the possibility of a change in trend before the change actually takes place.
Key Characteristics:
Predictive Nature: They aim to forecast price movements, giving traders a heads-up before a potential trend shift.
Prone to False Signals: Due to their anticipatory nature, leading indicators can often produce false signals, suggesting a trend change that doesn’t materialize.
Used for Short-Term Trading: Their predictive qualities can be particularly beneficial for short-term traders.
Examples:
Relative Strength Index (RSI): Measures the speed and change of price movements and indicates overbought or oversold conditions.
Stochastic Oscillator: Compares a security’s closing price to its price range over a specified period.
Fibonacci Retracements: Uses horizontal lines to highlight potential support and resistance levels.
Lagging Indicators
Lagging indicators confirm trends and movements after they’ve already begun. They are more reliable in terms of validation but might not be as useful for prediction.
Key Characteristics:
Confirmatory: They provide signals after the trend has started, offering confirmation rather than prediction.
Reduced False Signals: As they operate on historical data and confirm existing trends, they tend to have fewer false signals compared to leading indicators.
Used for Long-Term Trading: Their confirmatory nature makes them suitable for long-term traders or investors looking for validation of a trend.
Examples:
Moving Averages: The average price of a security over a specific number of periods. The most common types include the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
Moving Average Convergence Divergence (MACD): Monitors changes in the strength, direction, momentum, and duration of a trend in a stock’s price.
Bollinger Bands: Consist of a middle band being an N-period simple moving average (SMA) and two standard deviation lines, one above and another below the SMA.
Conclusion
Both leading and lagging indicators offer unique advantages and have their inherent challenges. The key is understanding their characteristics and applying them judiciously based on one’s trading strategy, goals, and risk tolerance. Remember, no indicator is foolproof. They should be used in conjunction with other tools, analysis methods, and sound risk management practices.
Lesson 15
Supertrend Indicator
The Super Trend Indicator (STI) is a versatile and widely-used tool in the realm of technical analysis. Designed to capture the essence of a prevailing trend, the STI assists traders in determining the primary direction of the market, helping them make more informed decisions about their trades.
What it is and what it shows
The Super Trend Indicator, typically visualized as a line on a chart, works by utilizing the Average True Range (ATR) in its calculations, and it adjusts itself based on the volatility of the underlying asset.
Key features of the Super Trend Indicator:
Directional Clarity: The STI provides clear buy and sell signals. When the price is above the Super Trend line and the line is green, it indicates a bullish trend. Conversely, when the price is below the line and the line is red, it suggests a bearish trend.
Adaptable to Volatility: By using the ATR in its formulation, the Super Trend Indicator is sensitive to price volatility, allowing it to adjust dynamically.
Simplicity: One of the primary appeals of the STI is its simplicity. It offers a straightforward visualization of the trend without the complexity of some other indicators.
How to trade it
When utilizing the Super Trend Indicator, consider the following guidelines:
Entry Points: A buy signal is generated when the Super Trend line turns green and is positioned below the price. A sell signal arises when the line turns red and is above the price.
Exit Points: Traders may consider closing their positions when the STI changes color, signaling a potential reversal in trend.
Stop Loss: The Super Trend line can be used as a stop loss level. For a long position, a trader can set the stop loss just below the Super Trend line. For a short position, the stop loss can be set just above it.
Combining with Other Indicators: To increase the reliability of the signals, combine the STI with other technical indicators like moving averages or momentum oscillators.
For example, in a chart where the STI turns from red to green and moves below the price, traders might consider this a favorable point to enter a long pos
ition. If used alongside a momentum oscillator that shows an overbought condition, traders might proceed with caution or wait for further confirmation.
An example of the Supertrend Indicator
The Super Trend Indicator offers traders an uncomplicated yet effective means to gauge the prevailing market trend. Its adaptability to volatility ensures its relevance across different market conditions. As with all technical tools, the STI is most effective when used in conjunction with other indicators and a well-thought-out trading strategy. By understanding its signals and limitations, traders can incorporate the STI into their toolkit to navigate the markets with greater confidence.