Technical Indicator Explantion-Moving Average Convergence Divergence (MACD)

Technical Indicator Explantion-Moving Average Convergence Divergence (MACD)

Moving Average Convergence Divergence (MACD)

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 12-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.

There are three common methods used to interpret the MACD:

1. Crossovers - As shown in the chart above, when the MACD falls below the signal line, it is a bearish signal, which indicates that it may be time to sell. Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a confirmed cross above the signal line before entering into a position to avoid getting getting "faked out" or entering into a position too early, as shown by the first arrow.

2. Divergence - When the security price diverges from the MACD. It signals the end of the current trend.

3. Dramatic rise - When the MACD rises dramatically - that is, the shorter moving average pulls away from the longer-term moving average - it is a signal that the security is overbought and will soon return to normal levels.

Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the MACD is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the MACD is below zero. As you can see from the chart above, the zero line often acts as an area of support and resistance for the indicator.

Saturday, January 13, 2007

Technical Indicator Explantion-Stochastic Oscillator

Stochastic Oscillator

Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the location of the current close relative to the high/low range over a set number of periods. Closing levels that are consistently near the top of the range indicate accumulation (buying pressure) and those near the bottom of the range indicate distribution (selling pressure).

A 14-day %K (14-period Stochastic Oscillator) would use the most recent close, the highest high over the last 14 days and the lowest low over the last 14 days. The number of periods will vary according to the sensitivity and the type of signals desired and %D is a 3-period moving average of %K.

The 80% value is used as an overbought warning signal, and the 20% is used as an oversold warning signal.

Signals

The Stochastic Oscillator generates signals in three main ways:
1. Extreme values when the 20% and 80% trigger lines are crossed.Buy when the stochastic falls below 20% and then rises above that level. Sell when the stochastic rises above 80% and then falls below that level.

2. Crossovers between the %D and %K lines.Buy when the %K line rises above the %D line. Sell when the %K line falls below the %D line. Beware of short-term crossovers. The preferred crossover is when the %K line intersects after the peak of the %D line (right-hand crossover).Crossovers often provide choppy signals that need to be filtered through the use of other indicators.

3. Divergences between the stochastic and the underlying price. For example, if prices are making a series of new highs and the stochastic is trending lower, you may have a warning signal of weakness in the market.


One of the most reliable signals is to wait for a divergence to develop from overbought or oversold levels. Once the oscillator reaches overbought levels, wait for a negative divergence to develop and then a cross below 80. This usually requires a double dip below 80 and the second dip results in the sell signal. For a buy signal, wait for a positive divergence to develop after the indicator moves below 20. This will usually require a trader to disregard the first break above 20. After the positive divergence forms, the second break above 20 confirms the divergence and a buy signal is given.


In Nov-99, a buy signal was given when the indicator formed a positive divergence and moved above 20 for the second time. Note that the double top in Nov-Dec (gray circle) was not a negative divergence -- the stock continued higher after this formed. In Jan-00, a sell signal was given when a negative divergence formed and the indicator dipped below 80 for the second time.

Technical Indicator Explantion-Bollinger Bands

Bollinger Bands

Developed by John Bollinger, Bollinger Bands are an indicator that allows users to compare volatility and relative price levels over a period time. The indicator consists of three bands designed to encompass the majority of a security's price action.

1. A simple moving average in the middle
2. An upper band (SMA plus 2 standard deviations)
3. A lower band (SMA minus 2 standard deviations)

Standard deviation is a statistical term that provides a good indication of volatility. Using the standard deviation ensures that the bands will react quickly to price movements and reflect periods of high and low volatility. Sharp price increases (or decreases), and hence volatility, will lead to a widening of the bands.

The centerline is the 20-day simple moving average. The upper band is the 20-day simple moving average plus 2 standard deviations. The lower band is the 20-day simple moving average less 2 standard deviations.

Signals:

a) Double bottom buy
A double bottom buy signal is given when prices penetrate the lower band and remain above the lower band after a subsequent low forms. Either low can be higher or lower than the other. The important thing is that the second low remains above the lower band. The bullish setup is confirmed when the price moves above the middle band, or simple moving average.

The stock penetrated the lower band in late September (red arrow) and then held above on the subsequent test in October. The October breakout above the middle band (green circle) provided the bullish confirmation.

b) Double top sell:
A sell signal is given when prices peak above the upper band and a subsequent peak fails to break above the upper band. The bearish setup is confirmed when prices decline below the middle band.

Sharp price changes can occur after the bands have tightened and volatility is low. In this instance, Bollinger Bands do not give any hint as to the future direction of prices. Direction must be determined using other indicators and aspects of technical analysis. Tight bands indicate low volatility and wide bands indicate high volatility.

In November, the bands were relatively wide and began to tighten over the next 2 months. By early January, the bands were the tightest in over 4 months (red circle). A little over a week later, the stock exploded for a 10+ point gain in less than 2 weeks

Even though Bollinger Bands can help generate buy and sell signals, they are not designed to determine the future direction of a security. The bands were designed to augment other analysis techniques and indicators. By themselves, Bollinger Bands serve two primary functions:
· To identify periods of high and low volatility
· To identify periods when prices are at extreme, and possibly unsustainable, levels.

Remember that buy and sell signals are not given when prices reach the upper or lower bands. Such levels merely indicate that prices are high or low on a relative basis. A security can become overbought or oversold for an extended period of time. Knowing whether or not prices are high or low on a relative basis can enhance our interpretation of other indicators and assist with timing issues in trading.

Technical Indicator Explantion-Relative Strength Index

Relative Strength Index

Relative Strength IndexThe Relative Strength Index (RSI) is a popular oscillator developed by Welles Wilder, Jr . RSI measures the relative changes between higher and lower closing prices, and provides an indication of overbought and oversold conditions. RSI is plotted on a vertical scale of 0 to 100. The 70% and 30% levels are used as warning signals. An RSI above 70% is considered overbought and below 30% is considered oversold. The 80% and 20% levels are preferred by some traders. The significance depends upon the time frame being considered. RSI signals should always be used in conjunction with trend-reversal signals offered by the price itself.
RSI can be plotted for any time span. Wilder originally recommended using a 14-day RSI. Since then, the 9, 10 and 25-day RSIs have also become popular. The shorter the time period, the more sensitive the oscillator becomes. If the user is trading short-term moves, the time period can be shortened. Lengthening the time period makes the oscillator smoother and narrower in amplitude.


Signals
a) Double Top Formation
Traders watch for double tops or what Wilder referred to as "failure swings." If the RSI makes a double top formation, with the first top above 70% and the second top below the first, you get a sell signal when the RSI falls below the level of the dip.

b) Double Bottom formation
Conversely, a double bottom at or below 30% (with the first low below 30% and the second at or above the same level) gives you a buy signal when the RSI breaks above the previous peak.

Failure Swings
Failure swing is a term that Wilder uses to refer to "very strong indications of a market reversal". Wilder uses failure swings to confirm his buy and sell points, and in the two figures below you can see that failure-swing points clearly do just that.These failure swings can lead to divergences between the price action and the RSI. For example, a divergence occurs when a market makes a new high or low, but the RSI fails to set a matching new high or low. A divergence can be an indication of an impending reversal. In Wilder's opinion, divergences are the most important signal provided by RSI.

taken from :http://stocktradingskills.blogspot.com/