Technical Indicators are signals, often derived from mathematic formulas, that are based upon patterns related to the price and/or volume of a security. By analyzing the historical price, volume, etc. of a security, an investor can more accurately predict future price movements. Before attempting to learn technical indicators, one needs to be well-versed in the principals of technical analysis. Listed below are some of the most favorited technical indicators of many experienced investors.
The accumulation/distribution line functions as a technical indicator that assesses whether a stock is being accumulated or distributed. To do this, the price and volume (the number of shares traded within a given period) of the security are examined, ultimately aiming to determine when the price of an asset is moving inversely in relation to its technical indicators. If the price is identified to be increasing whilst the indicators are decreasing, this may allude to a future price drop of the security. Thus, the accumulation/distribution line is a significant tool in determining a trend’s strength. A basic understanding of the accumulation/distribution line focuses on the trend of an asset: if there’s an upward trend, the price is rising and investors may choose to buy; if there’s a downward trend, the price is decreasing and investors may choose to sell.
The accumulation/distribution line can sound simple and advantageous to employ, yet it has its limitations. Primarily, the index does not account for price changes over the course of consecutive periods. Thus, when utilizing the accumulation/distribution line, it is of importance to also keep an eye on the price chart. Additionally, since the overall purpose of the index is to identify upward/downward trends, it is essential to exhibit patience. The forecasted changes to the price that the accumulation/distribution line provides may not take place overnight or even within the coming week, month, etc. Occasionally, the price may not shift at all. As with any technical indicator, it is crucial to also consult the basics of technical analysis in conjunction with other technical indicators before making any large decisions. Key takeaways and how to calculate the Accumulation/Distribution line can be read here.
By examining the highs and lows of an asset over a select period, the Aroon technical indicator aims to identify potential changes in price as well as the overall strength of the trend. “Aroon” is Sanskrit for “dawn’s early light”; thus, this indicator’s role is to determine new trends at their birth. There are two components to the Aroon indicator: Aroon up and Aroon down. As it sounds, the Aroon up line measures upward trends while the Aroon down line measures downward trends. Additionally, the Aroon up line assesses the number of periods since a High, and the Aroon down assesses the number of periods since a Low. Both the Aroon up and down lines oscillate between zero and one hundred; one hundred representing strength while zero represents weakness. Aroon-25 is the most typical period assessment of high and low trends. This signifies that the Aroon up and Aroon down identify potential price changes by examining the highs and lows of an asset over a 25 day period.
Since the Aroon indicator can readily identify new trends, it is essential to understand how. When the Aroon up jumps above the Aroon down, this may indicate the first stage of an uptrend. If the Aroon up moves above 50 while the Aroon down moves below 50, this further alludes to an emerging upward trend. Lastly, if the Aroon up tops at 100 while the Aroon down remains relatively low, an uptrend becomes highly likely.
The Aroon indicator piques many investors’ interest and can be a beneficial tool to use, but like any indicator, it has its faults. For many experts, the Aroon indicator has been known, at times, to provide false signals. Additionally, the Aroon indicator simply assesses the time passed between highs and lows, not the magnitude of the price movement. Thus, as always, it is important to consult other technical indicators and price analysis tools when utilizing the Aroon indicator. More information about the Aroon indicator is given here.
Average Directional Index (ADI/ADX)
To understands the Average Directional Index (ADI/ADX), one must become familiar with its sister indicators: the Negative Directional Index (-DI) and the Positive Directional Index (+DI). The +DI and -DI determine a trend’s direction over a period of time, while the ADI is constructed by averaging the +DI and -DI, ultimately assessing the overall strength of a trend. Thus, all three components can successfully measure the direction and strength of a trend. To obtain consistent ADI values, most experts agree that this index should evaluate data over the course of 150 periods. The ADI, alongside the -DI and +DI, can tell an investor whether a trade should or shouldn’t be executed, and if so, the length of the trade.
Due to the number of factors that construct the ADI, it is usually represented by three separate lines. A crossover between the +DI and -DI lines signifies a potential opportunity to trade an asset. If the +DI rises greater than the -DI, bulls have an advantage, meaning buying the asset is signaled. Conversely, when the -DI increases higher than the +DI, bears have the advantage and thus traders may want to sell. Welles Wilder, who developed the ADI, proposed that an ADX above 25 indicates a strong trend, while an ADX below 20 represents a complete lack of a trend. Many traders, however, will use an ADX of 20 as the baseline for a trade since the area between 20 and 25 is considered unknown territory. Read more about the Average Directional Index.
Average True Range (ATR)
The Average True Range (ATR), developed by Welles Wilder, aims to measure the market’s volatility. To do this, the ATR examines the full range of an asset’s price for a specific period. Typically, this data is accumulated over a period of fourteen days. However, the chosen period depends on one’s trading strategy. Since the ATR measures the volatility of an asset and not the direction of it, the method solely uses absolute values.
Before developing the ATR, Wilder developed True Range (TR). Wilder’s TR can be exemplified by three methods: the current High less the current Low, the current High less the previous Close, and the current Low less the previous Close. The first method listed functions as so: if the current period’s high outperform the high of the previous period and the current period’s low exceeds the low of the previous period, then the high-low range of the current period will define the TR. The second and third methods listed are utilized when the high of the previous period is higher than the current and when the low of the previous period is lower than the current. To calculate the ATR, a trader must find the absolute value of the current period’s high and the absolute value of the current period’s low and then subtract the two from each other. Then, a trader must find the absolute value of the current high subtracting the previous close, and the absolute value of the current low subtracting the previous close. A security that is enduring high volatility will in turn have a higher ATR. Conversely, a security exhibiting low volatility will have a lower ATR. The calculation of an ATR can convey to a trader whether or not they should enter or exit a trade. More information about the Average True Range (ATR) can be found here.
Chaikin Money Flow (CMF)
Developed by Marc Chaiken, the Chaiken Money Flow (CMF) is an average of accumulation and distribution over a specific period of time. For this technical indicator, typically a period of 21 days is used to calculate the CMF. In basic terms, the closer the closing price is to the high of the period, the more accumulation has occurred. On the other hand, the closer the closing price is to the low of the period, the more distribution has taken place. The CMF indicator functions by fluctuating near the zero line; it is nearly impossible for the indictor to reach either -1 or +1. Mostly, the CMF fluctuates between -0.5 and +0.5. A value above zero signifies strength while a value below zero signifies weakness. Thus, a move in a positive direction might signify to a trader to buy, while a move in a negative direction may signify to sell. Since the CMF fluctuates ever so slightly around the zero line, this indicator often releases false signals. Investors can counteract this potential possibility by setting limits and utilizing additional technical indicators. Read more information about the Chaikin Money Flow (CMF) oscillator.
Commodity Channel Index (CCI)
The Commodity Channel Index (CCI) is a technical indicator that aids in determining a new trend or in identifying extreme circumstances. It can also be beneficial for weighing an asset’s strength and direction as well as signaling to investors as to whether to enter or exit the market. At its core, the CCI’s main function is to calculate the difference between the current price of a security and its average price over a specific period. When the price is well above its average, strength is indicated. Conversely, when the price is far below its average, weakness is indicated.
To calculate the CCI, one needs to first decide upon the number of periods to use within the formula. The most common number of periods utilized is 20; anything lower might result in more volatile results while anything higher will give smoother data. A deeper understanding of the calculation process can be found on StockCharts. As previously stated, the CCI’s main purpose is identifying new trends. Hence, the results from calculating the CCI are helpful in discovering upward and downward trends. When the CCI increases from negative or around zero to over one hundred, a new upward trend may be indicated. On the other hand, if the CCI dives to negative one hundred, a downward trend may be indicated. Weakness can also be indicated by inverse relationships between the price and the CCI, such as when price rises while the CCI falls. These such divergences aren’t always the most reliable trade indicators, yet they can serve as a warning to investors before it is too late. Limitations and key takeaways of the Commodity Channel Index (CCI) can be read here.
The Coppock Curve is a technical indicator that focuses on long-term momentum. Mainly, it is used to find buying opportunities within the more popular long term investments such as the S&P 500 and the Dow Industrials. This technical indicator can be best understood as a momentum oscillator that bounces around zero. The Curve is a compilation of rates of change, which measures the percentage of the change in price from one period to the next. Edwin Coppock, the developer of the Coppock Curve, chose to concoct rates of change using periods of eleven and fourteen months, and thus many investors utilize these periods. To indicate a buy, the Coppock curve would have the move into positive territory, while a sell would be indicated by negative territory. However, since the Coppock Curve is used for medium to long term investments, the buy-and-sell signals do not happen that often. For the most part, when investing in popular long-term investments such as the S&P 500, you can trust that the investment platforms have already calculated the curve and applied its data effectively.
The correlation coefficient compares two securities together, measuring the strength of their relationship. The values of the correlation coefficient fluctuate between -1.0 and +1.0; any result outside of this range would indicate an error in the calculation. When a correlation coefficient exactly meets either -1.0 and +1.0, it is considered either perfectly positive or perfectly negative. These moments of perfection are exceptionally rare. Positivity illustrates that both securities are moving in the same direction, either up or down. On the other hand, negativity demonstrates that both securities are moving in opposite directions. The most commonly used form of the correlation coefficient is called known as the Pearson correlation. The Pearson correlation observes the linear relationship between two securities, meaning a straight-line relationship. Due to this, the Pearson correlation cannot account for variables or take into consideration nonlinear relationships. Understanding the correlation coefficient is important if an investor desires the understand relationships within the market that can ultimately affect the price and direction of a security. Additionally, understanding the relationship between securities, or more accurately the lack thereof, can aid in diversifying one’s portfolio and thus can decrease risk. Key takeaways on the Correlation Coefficient can be found here.
Detrended Price Oscillator (DPO)
The Detrended Price Oscillator (DPO) is a technical indicator that does just what it sounds: strip the trend away from the price. Removing the trend from the price of a security can create a clearer picture of price cycles and their length. It is important to note that the DPO is not a momentum oscillator; rather, it simply examines price. In basic terms, the DPO highlights the highs and lows of the price cycle, thus signaling when the buy or sell. Typically, when calculating the DPO, between 20 to 30 of the previous periods are examined. By observing historical highs and lows, an investor may be able to predict when the next price low will arrive, thus signaling a buy. This same methodology can be utilized to sell.
The DPO is useful when attempting to predict future price points, but at the end of the day, it is just that: a prediction. There is never a guarantee that a price cycle will repeat itself in the future, and therefore utilizing the DPO for future investment plans can be risky. Additionally, since the technical indicator does not consider the trend, it is important for traders to consult other indicators before entering the market.
Ease of Movement (EMV)
Developed by Richard Arms, Ease of Movement (EMV) is a technical indicator that attempts to measure volume. As it sounds, EMV seeks to quantify the ease of price movements. The value derived from EMV ultimately provides information as to whether prices will rise or fall. EMV is an oscillator; as a result, its conclusions will fluctuate around the zero line. When it lands within positive territory, this signals that prices are increasing with some amount of ease. On the other hand, when it falls to negative territory, prices are declining with some amount of ease.
At first glance, one may think that EMV seems confusingly useless; however, this is not the case. If prices move with ease, they will most likely continue to move with ease for some time; thus, ease can be quite beneficial for trading purposes. Perhaps, though, its greatest potential lies within its impeccable teamwork capabilities. All technical indicators should never be employed alone, yet this cannot be stressed enough concerning EMV. EMV’s practicality becomes abundantly clear when used alongside other technical indicators. This is due to the fact that the values provided can be utilized within chart analysis and can also validate data found using other indicators. In fact, the most beneficial aspect of EMV is its ability to corroborate or negate the conclusions found by employing outside techniques.
The force index is a technical indicator that is responsible for discovering just how much force has been used to move the price of a security. To do this, the force index utilizes price and volume to quantify the force behind the movement as well as potential future price turns. This index is an oscillator, meaning that it flutters from negative to positive territory and vice versa. However, this oscillator is unique in what it is constructed of. Alexander Elder, who coined the force index, believed strongly in his essential components of a security’s price movement: direction, extent, and volume. Due to its particular composure, the force index can be utilized to discover a new emerging trend, to find divergences, and to identify potential future turns in price.
The first aspect that the force index considers is price change. If the price changes in a positive direction, previous buyers come out on top, while if the prices declines, sellers prevail. Secondly, Elder’s force index examines what is referred to as extent, which illustrates how far prices have moved. Lastly, the volume is weighed. To Elder, the volume is a measure of the commitment from buyers and sellers alike. Once calculated, the force index is capable of providing a large amount of information. If the force index is of high value, this signals quite strong price movements. Price and the force index share a direct relationship. As such, if the price soars, the force index should as well. Conversely, if the price falls, the force index should follow suit. However, potentially the most important piece of data that the force index can derive is the identification of future trends. In general, volume is a key component of discovering trends. Hence, since the force index examines both volume and price, it is an exceptionally useful tool. Nevertheless, it should not be utilized alone. In fact, it might be better suited as a tool for confirming a potential trend than locating one.
Know Sure Thing (KST)
The Know Sure Thing (KST) is a momentum oscillator that aids in the interpretation and understanding of rate-of-change. This technical indicator was commonly referred to by its developer, Martin Pring, as the “summed rate of change”. This is due to the KST’s analysis of rate-of-change over four different periods and the consequent summation of its findings. As an oscillator, the KST fluctuates around the zero line. When the KST is above the zero line, the prices are increasing, and thus a buy signal is indicated. When below the zero line, prices are falling, and thus a sell signal is indicated. In addition to centerline crossovers, investors can also examine crossovers between the KST and the signal line. Generally speaking, the KST is rising when above the signal line and falling when below it. This data translates into directional and momentum indicators. For example, a rising yet negative KST indicates that the downward momentum is slowing down. A falling yet positive KST indicates that upward momentum is slowing. Observing crossovers of the centerline and signal line are the most basic and prosperous mechanisms of utilizing the KST. However, when combined with other aspects of technical analysis, the data gained from the KST becomes stronger. It is important to weigh other technical indicators and examine other factors, such as an asset’s volume, before making any decisions.
The Mass Index is a technical indicator that considers the high and low range of a security’s price over a specified period. Developed by Donald Dorsey, the Mass Index was created with the aim of discovering trend reversals based on expansions in the range of price. Dorsey called these particular expansions in range “reversal bulges”. According to his methodology, when the Mass Index is calculated to be above 27 and then drops below 26.5, a change in the trend can be expected. However, a security with a Mass Index above 27 is extremely rare and mostly seen within quite volatile stocks. When used alongside other technical indicators, the qualifications made by Dorsey can safely be tweaked. Since the Mass Index focuses mainly on price and volume, employing its principles alongside a technical indicator that measures direction would be ideal for constructing data for beneficial trading.
Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence (MACD) is an oscillator that follows trends, ultimately illustrating the relationship between two moving averages of a security’s price. Thus, the MACD follows trends while also examining momentum. This technical indicator results in a line that fluctuates around the zero line. When the moving averages cross over or diverge, a trader can identify buy and sell points. When the MACD is moving in a positive direction, this signals that the upside momentum is increasing. Conversely, when the MACD is moving in a negative direction, the downside momentum is increasing. To calculate the MACD, one needs to become comfortable with the Exponential Moving Average (EMA). The EMA is a Moving Average (MA) that examines recent data points and thus reacts more significantly to recent price changes. To calculate the MACD, the 26-period EMA of a security needs to be subtracted from the 12-period EMA. Often, the 12-period average moves quicker than the 26-period EMA and is thus most responsible for overall MACD movements.
An important component of the MACD is what is commonly referred to as the signal line. The signal line is a 9-period Exponential Moving Average (EMA) of the MACD. When the MACD moves above the signal line, it indicates a potential opportunity to buy. On the other hand, when the MACD moves below the signal line a trader may opt to sell. Though the signal line sounds like a simple method in identify entry and exit points, an investor should be wary of extreme signal line crossovers which may signal volatility. Overall, the MACD is a unique technical indicator because it combines momentum and trend, but when employing this indicator, it is important to remain cautious. The MACD can produce false signals and thus a trader should consult other technical indicators before making any brash decisions. For more information about MACD and key takeaways are presented here.
Money Flow Index (MFI)
Coined by Gene Quong and Avrum Soudack the Money Flow Index (MFI) is a technical indicator that examines both price and volume to discover overbought or oversold signals within an asset. The MFI functions as an oscillator that flutters between 0 and 100; however, it is one of the more unique oscillating technical indicators. Most oscillators only examine the price of an asset, but as already mentioned, the MFI employs both price and volume. The MFI’s utility and purpose surround the typical price of an asset. If the typical price rises, the MFI is positive and a trader may be inclined to buy. Conversely, if the typical price falls, the MFI is negative and a trader may desire to sell.
The MFI’s primary usage comes with the presence of a divergence. A divergence occurs when the price and oscillator move in opposing directions. Divergences between price and the MFI oscillator indicate potential price reversals: if the MFI declines while the price continues to increase, and price reversal to the downside may be occurring. On the other hand, if the MFI increases while the price falls, a price reversal to the upside might be taking place. As previously discussed, the MFI can also be utilized to identify overbought or oversold signals. These particular signals are incredibly useful, as an indication of an overbought or oversold asset may indicate future unsustainability of the security. An MFI valued above 80 typically indicates that a security has been overbought, while an MFI below 20 signals that the security has been oversold. MFI moves that reach 90 and 10 are considered extreme and rare; however, they do occur. Quong and Soudack say MFI values of 90 or 10 indicate overbought and oversold signals that are absolute.
As with all indicators, the MFI should never be used alone. It has its limitations, as they all do, and may potentially give false signals. A good trading opportunity may be indicated by the MFI, but the price could potentially not move in the way that the MFI expected it to. Additionally, divergences may not always create price reversals. As with most indicators, the MFI does its best work alongside another indicator or two; please see here for more information.
Negative Volume Index (NVI)
The Negative Volume Index (NVI) is a technical indicator that weighs both volume and price to graphically illustrate how volume affects price movements. The relationship between price and volume is represented as a trendline and is often considered one of the best trendlines for tracking smart money. In simple terms, smart money refers to investments made by those who are informed and experienced investors. Understanding smart money highlights the importance of the NVI. When an asset’s volume is low, smart money is active. Conversely, when the volume is high, smart money is inactive.
Traditionally, employing the principles of the NVI is fairly simple. The market is considered to be on the rise when the NVI rises above a security’s 255 day Exponential Moving Average (EMA), while the market is considered to be falling when the NVI falls below the 225 day EMA. However, many investors note that the NVI’s traditional relationship to EMA is not always the best predictor. Many times, a healthy market can be predicted with near certainty in relation to the 255 day EMA, yet the potential for a market decline is still quite high. As always, taking into consideration other technical indicators is most beneficial for utilizing the NVI.
On-Balance Volume (OBV)
The On-Balance Volume (OBV) is a technical indicator that uses volume to anticipate future price changes. Joseph Granville, the creator of the OBV, believed strongly in the power of volume within markets. For Granville, if the volume were to drastically increase, then the price of the security would either significantly increase or decrease. A high OBV value signals a potential price increase, while a lower OBV indicates a price drop. The OBV is a cumulative indicator, meaning that it factors into consideration data over a specified length of time. For instance, if the OBV of a security was measured over the course of 15 days, the amount of volume from high volume days would be added to the overall OBV while the volume from low volume days would be subtracted from the overall OBV. However, the exact concluding amount of volume is not of much importance. Rather, since the OBV is plotted on a price chart, the visual aspects of the OBV line are what is most beneficial for anticipating future price movements.
As with most predictive indicators, the OBV can produce false signals. However, that does not mean one should be wary of utilizing the OBV. Alongside other technical indicators, the OBV has great strength and success. Granville strongly believed that movements in volume precede movements in price. If this is accurate, the OBV could not be more useful.
Percentage Price Oscillator (PPO)
The Percentage Price Oscillator (PPO) is a momentum oscillator that highlights the relationship between two movement averages. The two movement averages compared are a 12-day Exponential Moving Average (EMA) and a 26 day EMA. Mainly, this technical indicator is employed to assess a security’s performance and volatility, to spot divergences, and confirm trends. The PPO is represented by two lines: a signal line and a centerline. The signals received from the PPO are illustrated by signal line crossovers, centerline crossovers, and divergences. As you may quickly notice, the methodology and representation of the PPO is incredibly similar to that of the MACD; however, the PPO measures percentage differences between EMA’s while the MACD measures absolute price differences.
Similarly to the MACD, the PPO provides trade signals that can tell an investor whether to enter or exit the market. If the PPO line begins below the signal line and then increases above it, this indicates a potential moment to buy. Conversely, if the PPO line begins above the signal line and then drops below it, a sell signal is indicated. If the value of the PPO is above zero, an upward trend is signaled. On the other hand, when the value of the PPO is below zero, a downward trend is indicated. Crossovers of the centerline also provide information as to whether to enter or exit the market. If the centerline is moving upward a bullish market would be illustrated, while a centerline movement downward would signify a bearish market. In addition to spotting entry and exit points, the PPO can be utilized to spot divergences in the relationship between the price and the indicator. If the price is higher than the indicator, then the upward momentum may be slowing. If the price is lower than the indicator, a rise in price may be coming in the near future. Lastly, the PPO can also be used to compare assets, which is most useful when two assets vary greatly in price. Using the PPO, a stock priced at $15.00 can be compared to a stock priced at $2,000. Since the PPO measures both performance and volatility, it can be utilized to express concerns or benefits of an asset that cannot be expressed by the price. Thus, the PPO can attempt to highlight a stock’s performance and volatility in relation to another and hence indicate to an investor which stock is the more healthy and secure investment.
Rate of Change (ROC)
The Rate of Change (ROC) can be simply understood as momentum itself, meaning that it is an oscillator that purely consists of momentum. This is because the ROC calculates the percent change of price from the current period and also from a past period. As an oscillator, it fluctuates around the zero line and thus can be employed to identify divergences, overbought and oversold conditions, and trend changes. When the ROC is above the zero line, prices can be expected to rise. When below, prices can be expected to drop. Divergences are identified when the ROC does not follow the price. In other words, if the ROC increases while the price decreases, there is a divergence. Conversely, if the ROC decreases while the price increases, there is a divergence. Overbought and oversold conditions can be discovered by monitoring the ROC and price of an asset. If the ROC reaches an extreme, overbought or oversold conditions may be indicated. Lastly, trend changes can be observed by monitoring zero line crossovers. There are 250 trading days in a year; this can be broken down into half-year, quarter year, and monthly. When attempting to identify future trends, an investor should compare the ROC of the entire year and the half-year. If the ROC is in positive territory for both of those time frames, an uptrend may be indicated. However, it is important to note that most experts would never simply use the ROC for identifying trends. Rather, the ROC merely serves as a warning for a potential trend reversal and should be utilized alongside other technical indicators that may be able to validate the potential trend reversal.
As with any technical indicator, the ROC has its limitations. For one, it is prone to whipsaws, or volatile and short term price movements. These rapid movements can result in false signals and thus can lead investors in the wrong direction. Additionally, divergence signals provided by the ROC occur early on while the trend is still moving; therefore, divergence indicators should not be used as trade signals. Overall, the ROC should be used alongside other indicators of technical analysis.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a technical indicator that measures recent price changes. Mainly, this indicator is employed to identify and evaluate overbought and oversold conditions. The RSI functions as an oscillator that fluctuates between zero and 100. According to its developer, Welles Wilder, an RSI of above 70 indicates overbought conditions while an RSI below 30 indicates oversold conditions. Wilder’s RSI can also be utilized to examine divergences. When the security performs a lower low than the RSI, a bullish divergence has occurred. Conversely, when a security performs a higher high than the RSI, a bearish divergence has occurred. The RSI is also notoriously known for its swinging capabilities. When examined closely, these swings can predict the future price of an asset. Each investor has their own interpretation of these swings, but there are four basic and robust steps for examining swings. If the RSI dips below 30 and indicates that an asset is oversold, then rises, then falls just above 30, and then rises drastically, a bullish swing has occurred. On the other hand, if the RSI rises above 70 indicating an asset is overbought, drops, then rises below 70, and then fails to exceed 70, a bearish swing has occurred. For many investors, learning how to interpret RSI swings is an incredibly useful tactic for predicting future price swings.
The RSI is a quite unique and effective technical indicator that has been employed for decades. Its unparalleled oscillation range and ability to provide indications through swings has made the RSI a favorite index for many investors. As with any indicator, there are drawbacks. It has the potential to deliver false signals and is most useful for examining long term trends. However, since the days of Wilder, many other experts have contributed to the RSI and have tweaked its ranges and methodology. With a thorough understanding of the RSI, the data provided can become some of the most strategic information for traders to utilize. Key takeaways regarding the Relative Strength Index are discussed.
Developed by George C. Lane, the Stochastic Oscillator is a technical indicator that compares a specific closing price to the high-low range of price over a particular period of time. According to Lane, this oscillator solely follows momentum or speed of price changes. Primarily, the Stochastic Oscillator is beneficial for identifying future reversals and for recognizing overbought or oversold conditions. Due to the fact it is an oscillator, this indicator ranges between zero and 100. This specific range is particularly useful for identifying overbought and oversold conditions. According to its principles, if the Stochastic Oscillator is over 80 overbought conditions are indicated while oversold conditions are indicated by readings under 20. These sets of data can be used to predict reversals, but they are not always correct in doing so. Thus, depending on one’s chosen asset, these thresholds (80 and 20) can be adjusted. To predict potential reversals using the Stochastic Oscillator, an investor would need to observe divergences. Divergences occur when the readings of the Stochastic Oscillator do not match with the price of the security. For example, a bullish divergence develops when the price is lower than the Stochastic Oscillator while a bearish divergence develops when the price is higher than the Stochastic Oscillator. Identifying divergences is one of the best methods for foretelling future reversals, thus the divergences between the price and this technical indicator are important to monitor. Read more about the key takeaways of the Stochastic Oscillator.
True Strength Index (TSI)
The True Strength Index (TSI) is a technical indicator that bases itself on double smoothed price changes of an asset. It is also a momentum oscillator that fluctuates between negative and positive territory. Generally, the TSI is useful for identifying overbought and oversold conditions, potential trend reversals, and divergences. When the TSI lands in positive territory, prices are rising and a buy signal is given. Conversely, when the TSI lands in negative territory, prices are falling and traders may choose to sell. In addition to monitoring crosses over the center line, an investor can add a signal line to a chart to observe more crossovers. Crossovers of the signal line and the TSI follow the same principles as the centerline: when the TSI is above the signal line, a buy is indicated; if the TSI is below the signal line, a sell is indicated. Identifying overbought and oversold conditions using the TSI becomes more complicated than previously discussed indicators. Since the TSI is based on price, the oversold and overbought levels are based entirely on the asset itself and cannot be generally quantified in a range.
The TSI is a unique oscillating technical indicator due to the fact that it is based on double smoothed price changes of an asset, which is beneficial in lessening the volatility that is often provided by other oscillating indicators. However, it does have its limitations. Like other technical indicators, it is known for providing false signals. Additionally, signal line crossovers with the TSI are often frequent and most likely not the best trading signals. It is important to weigh other technical indicators alongside the TSI before entering or exiting the market.
Developed by Peter Martin and Byron McCan, the Ulcer Index measures downside risk by examining a security’s duration of price decline and its overall depth. To understand the purpose of the Ulcer Index, one must become familiar with its creation. Martin and McCann produced the Ulcer index with mutual funds in mind. Mutual funds consist of a pool of money from various different investors. If bought into, an investor would then make a profit from an increase in the value of the mutual stock. Therefore, the main drawback involved in purchasing this type of asset is the downside risk. Hence the name of the index, Martin and McCann set out to create a technical indicator that could assess the amount of risk an investor could expect “to stomach”. The Ulcer Index’s relationship with the price of an asset is quite simple: its value increases as the price moves away from a recent high, while its value decreases as the price rises to new highs. Generally, the Ulcer Index is calculated using a 14-day period, yet this can be modified depending on an investor’s strategy.
As you may already notice, a lower Ulcer Index value is beneficial for an investor. A high index value signals that it might take some time for the security’s price to recover. While important for understanding an investor’s own asset, it can perhaps be even more useful for comparing assets one hasn’t bought yet. If multiple securities are compared, an investor can measure which has the lowest risk and thus which asset is safer to purchase and contains less potential volatility. However, it is important to note that the Ulcer Index is only one measure of volatility and not the best one at that. If attempting to understand an asset’s volatility, an investor should utilize the Ulcer Index alongside another technical indicator that is best suited for the task. Overall, the Ulcer Index is a favorite of many investors when it comes to understanding one’s potential risk and/or how securities compare to one another. Since it calculates downside risk by examining price declines, it is best suited for long-term investors. The Ulcer Index is less of an indicator than most, and as such, it is important to also assess the data from other technical indicators.
The Ultimate Oscillator is similar to most other oscillators in that it measures the price momentum of a security. However, its creator, Larry Williams, set out to create a momentum oscillator that was both different and more accurate than the others; hence why he named it the “Ultimate Oscillator”. Williams’ development stands out not due to its basic functioning but by the periods it examines. Most other oscillators observe price momentum within one timeframe; Williams’ oscillator observes price momentum over the course of three timeframes. The result of measuring price momentum over a longer period of time is less indicator volatility, meaning it will present fewer trade signals and thus fewer false signals.
In its original form, this technical indicator measures price momentum over three specific timeframes: 7 periods, 14 periods, and 28 periods. These specific periods can be tweaked a bit, but one rule remains the same: the second timeframe must be double the first and the third timeframe must be double the second. With this in mind, this oscillator can be used within a day, a week, or a month depending on an investor’s needs. When calculating the Ultimate Oscillator, the shorter timeframe (ex: 7 periods) has the most weight while the longer timeframe (ex: 28 periods) has the least. Buy and sell signals are indicated by divergences between price and the oscillator, but there are a few steps for each. For a buy signal, the first step occurs when the Ultimate Oscillator presents a higher low than the price. However, the second step mandates that the low of the divergence must be below 30. Lastly, the oscillator must rise above the high of the divergence. Once that is all said and done, a buy signal has been indicated. On the other hand, the first step of a sell signal occurs when the Ultimate Oscillator performs a lower high than the price. The second step states that the high of this divergence should be above 70. Lastly, the Ultimate Oscillator must drop below the low of the divergence. Once these steps are complete, a sell signal is indicated. If this technical indicator produces levels below 30, a security is considered oversold. Conversely, levels above 70 indicate that a security has been overbought.
The Ultimate Oscillator is a wonderful technical indicator for receiving fewer and less inaccurate trade signals. However, while it eliminates some bad trades, its methodology may also eliminate good ones. As such, the Ultimate Oscillator should not be used alone and performs its best alongside other technical indicators.
The Vortex Indicator (VI) is a technical indicator that is composed of two lines: one captures positive trend movement (VI+) while the other captures negative trend movement (VI-). Generally, the VI is employed to identify trade reversals and confirm current trends. The calculation for this indicator can seem rather daunting, but its results are fairly simple to understand. The VI is plotted on a graph with each line (VI+ and VI-) having its own color. Normally, the VI+ is green while the VI- is red. A buy signal is indicated when the VI+ crosses above the VI- while a sell signal is generated by the VI- crossing above the VI+. However, VI+ and VI- crossovers are not always accurate and can portray false trading signals. Some experts suggest increasing the period used in the calculation to avoid this. Yet perhaps the most crucial action one can take to avoid false trading signals is to utilize the VI alongside other technical indicators that are known for following trends. The VI is not a standalone indicator by any means and should always be used in conjunction with other components of technical analysis.
The Williams %R is a technical indicator that identifies oversold and overbought conditions as well as locates entry and exit points in the market. As you will soon discover, the Williams %R is quite similar to the Stochastic Oscillator in that it examines the relationship between the closing price and the previous price. While the Stochastic Oscillator observes the relationship between the closing price and previous low, the Williams %R observes the closing price in relation to the previous high. This technical indicator ranges from 0 to -100. In accordance with this, a level above -20 indicates a security has been overbought while a level below -80 indicates a security has been oversold. When the price and the indicator move out of either overbought or oversold territory, buy and sell points are indicated. Nevertheless, an investor should not only follow the Williams %R around -20 and -80; the centerline of -50 is also of extreme importance. When the Williams %R crosses above -50, prices are trading in the upper half of their range. Conversely, when the Williams %R crosses below -50, prices are trading in the lower half of their range.
The William %R functions inversely to the Stochastic Oscillator, and thus can provide interesting and useful data. However, as all technical indicators do, it has its drawbacks. For one, overbought and oversold conditions do not always indicate a future reversal. Rather, they are more beneficial for confirming trends than predicting future events. Additionally, the Williams %R can provide false signals. As always, to avoid these potential risks it is important to use the Williams %R alongside other technical indicators.