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The Average Directional Index or ADX was developed by J.Welles Wilder and is a trend indicator. Most indicators have one major weakness - they are not suited for use in both trending and ranging markets. The ADX indicator measures the strength of a trend. Therefore it provides high readings for both a strong upward trend or a strong downtrend. Low ADX values indicates the absence of trend or a range bound market. Low readings should provide the cues for monitoring other indicators for potential breakout patterns e.g. candlestick formations, Bollinger Band constriction and momentum divergences. Alpha represents the degree to which a portfolio manager outperforms/underperforms the market (usually measured in relation to the S&P 500 or other benchmark index) independently of the risk that he/she has taken with respect to the security's Beta value. It can also be determined with respect to any individual security by using a process of linear regression of the returns on the security versus the return on the benchmark. The alpha value is the y-intecept value of the linear equation found from regression and a positive value indicates that the security has - even on a risk adjusted basis - out-performed the overall market, whereas a negative alpha value indicates relative under-performance. A Bear Flag is a multi-period price/volume formation that shows a rising pullback channel following a recent downward thrust on heavy volume. The flag pole for this pattern is created during the downthrust phase when the daily range has to be twice the recent average true range and volume has to be twice the recent average volume. During the pullback channel phase the pattern is far more reliable if the volume remains modest. The pattern is violated if price moves above the breakout level (the base of the flag pole) or fails intraday below the "top" of the flag pole. The beta value of a security indicates the manner in which its movements are associated with the movement of a benchmark index such as the S&P 500. A beta value of 2 for example indicates that the security will move twice as much - both up and down - as the benchmark. It can be determined with respect to any individual security by using a process of linear regression of the returns on the security versus the return on the benchmark. The beta value is the gradient value of the linear equation found from the regression. Bollinger bands, named after the analyst who has promoted their usage, which are also known more generally as volatility bands, are used widely by market traders. The manner in which they are constructed is as follows. An SMA or simple moving average of the closing price during the last (say) 50 periods is calculated. During this same period the standard deviation of the closing price is also calculated. The standard deviation is an indication of the volatility of the price during this same period. In a similar manner in which, say, the heights of individual adult males are dispersed in relation to the average height of an adult male, the standard deviation or sigma of the price over the last 50 trading sessions can be calculated from the variance of each of the separate closing prices from the moving average. Probability assumptions based upon the normal distribution and which is expected (mistakenly) to apply to the performance of asset prices, is implicitly assumed and a channel is plotted between which prices are expected to move during the period under consideration. The notion is that when you add 2 sigmas or standard deviations to the average you will be able to plot the point for the upper Bollinger band and when you subtract 2 sigmas or standard deviations from the average you can then plot the point for the lower Bollinger band. This channel or “envelope” between the bands is presumed to represent the boundaries within which prices are expected to move with a 95% degree of confidence. A Bull Flag is a multi-period price/volume formation that shows a falling pullback channel following a recent upward thrust on heavy volume. The flag pole for this pattern is created during the upthrust phase when the daily range has to be twice the recent average true range and volume has to be twice the recent average volume. During the pullback channel phase the pattern is far more reliable if the volume remains modest. The pattern is violated if price moves below the breakout level (the bottom of the flag pole) or fails intraday above the top of the flag pole. Closing Bias is calculated very simply with the following formula: CLOSE-LOW / (HIGH-LOW). It will have a value between 0 and 100 which can be thought of in percentage terms. A value of 0% indicates that the closing price is equal to the low for the day and a value of 50% would indicate that the closing price was in the mid point of the daily range and a value of 100% would indicate that the close and the high for the day were the same value. Dissonance is a mental state in which a person is conflicted, entertaining different thoughts or beliefs that are contradictory. To give it an extended meaning it can be seen not as just a property of a single human mind, but also a collective mind i.e. a financial market. Market Dissonance is the manifestation of discordance amongst price and other dynamics – momentum, volume, money flow and relative strength. Examples of dissonant market behavior:
The principal characteristic of the Doji formation is that the opening and closing price are either the same or almost the same.The formation can display an upper and /or lower shadow and if these become significant the Doji can then approximate the Spinning Top formation. In the limiting case where the open and close are identical and the shadows are very small the Doji formation is sometimes known as a "Star". Doji formations often presage a reversal and can also point to indecision. The Evening Star Candlestick formation is a bearish reversal pattern that is especially significant if it occurs during a sustained uptrend. It is a three day chart pattern in which the first day shows a candle with a long green body. On the second day there is a gap up with a small body candle registered. On the third day, a candle with a relatively long red body is recorded. Ideally for the pattern the most recent day's close should be below the midpoint of the first day's candle range. The deeper the third candle moves into the real body of the first day's candle, the more reliable the reversal signal. This pattern is the converse of the Morning Star formation. The Fisher Transform indicator was developed by John Ehlers who is also a renowned expert on cycles in technical analysis. It is designed to give more timely signals as to trend inflections than more conventional techniques such as MACD and RSI. There is a good article by Ehlers about the techniques involved in calculating the Fisher Transform values here . In essence, the Fisher Transform converts price data to a nearly Gaussian probability density function. The result is an indicator that reverses very sharply when a trend changes. Flag Duration Values show the time duration of the flag pattern from the completion of the flag pole formation stage to the current session. In other words, the count represents the number of sessions that have elapsed during the channel phase of the chart pattern. Our experience suggests that, genrally speaking, the longer the duration the less reliable the pattern becomes. However there are exceptions to that simple rule; when the overall market is in a congestion phase, longer duration values are to be expected, and they may not diminish the reliability of the signal. Typically the duration that we look for in our scanning algorithms is between five and twelve days. For all Doji candlestick formations the opening and closing price are either the same or almost the same. In the case of a gravestone doji there is also a notably long upper shadow or tail which shows that traders encountered strong price rejection at higher levels than where the price closed. A further qualification for this pattern is that it should be at a multi-period high for the security. Hammer candlestick patterns are characterized by a relatively small body, that may be of either color, that sits on top of a long shadow or tail. The formation should ideally have no upper shadow or a very small one as it would then begin to more resemble a Spinning Top formation. When a Hammer candle occurs near a significant chart low it suggests that there is underlying buying interest right under the current closing price. Hanging Man candlesticks have the same appearance as a Hammer candle but what is required for this classification is that the pattern should occur at the top of a trading range or at chart locations that represent a significant high mark for the security. The long lower shadow or tail to this formation suggests, when it is associated with prices at upper extremes, that there will be many traders that could be left stranded should the price begin to falter in subsequent sessions. The Harami Candlestick formation is a two day pattern that has a small body day completely contained within the range of the previous candle's body. This pattern is also often referred to as an inside day and we attach added significance to this pattern when the preceding candlestick has a long body and occurred at a price extreme such as the top or bottom of a trading range. HARAMI CANDLESTICK-INSIDE DAY AFTER PEEK TOP This formation is a type of Harami candlestick. In this pattern the current session signifies an inside day following a peek at a 20 period high value. A peek can be defined as less than one percent from the 20 day high or within three sessions of the occurrence of that 20 day high. HARAMI CANDLESTICK-INSIDE DAY AFTER PEEK BOTTOM This formation is a type of Harami candlestick. In this pattern the current session signifies an inside day following a peek at a 20 period low value. A peek can be defined as less than one percent from the 20 day low or within three sessions of the occurrence of that 20 day low. Translated from the Japanese, Ichimoku means instant view or one glance, Kinko means equilibrium or balance and Hyo means chart. The Ichimoku charting technique and analytics provide a trend-following indicator but with key difference that the chart lines are shifted forward in time. Time shifting forwards creates wider support and resistance zones and can decrease the risk of trading false breakouts, but this is less reliabe in non-trending markets. Ichimoku charts are made up of four principal lines and one optional one:
Ichimoku is primarily a system for markets that are trending. It is not so useful for sideways markets. The thicker the cloud, the less likely it is that prices will manage a sustained break through it, regardless of whether Span A or Span B is on top Software packages strongly distinguish these two cloud types by the use of different colours, but in reality it is the thickness of a cloud which really matters A trend reversal could be suggested if the price moves through the cloud and closes beyond the cloud If the price moves into the cloud but fails to go through it a reversal may be imminent. Here are some other basic interpretation rules:
An inside session is one where the intraday range covered is completely engulfed by the previous session's intraday range. In other words the current session's high is below the previous high and the current session's low is above the previous session's low. Larry Williams, in some of his writings, attaches significance to inside sessions for their predictive potential especially when found in conjnction with other inflection formations such as Doji candlesticks. The Inverted Hammer candlestick formation is often a reversal signal, especially if it occurs after a prolonged period of price weakness or near a significant low in the chart formation. It consists of a small candle body formed near the bottom of the day's price range. The upper shadow should be no more than twice as long as the candle body and the lower shadow should be small or non-existent. Sometimes this formation is found as the middle candle in a Morning star formation An Island Candlestick Formation is recorded when there is no overlap between the full candlestick ranges for the current session, the previous session and the session before that. If this formation occurs in conjunction with a Morning Star or Evening Star it indicates a major reversal pattern. MOVING AVERAGE CONVERGENCE/DIVERGENCE [MACD] Moving Average Convergence/Divergence (MACD) was developed by Gerald Appel and is one of the most reliable technical indicators available. MACD uses moving averages to derive a momentum oscillator that subtracts the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. The most popular formula of the MACD is the difference between a 26-day and a 12-day exponential moving average. Appel and others have expeimented with different time periods to come up with an indicator that is more flexible and to analyse securities with different volatility characteristics and market conditions. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator, less prone to whipsaws. In the canonical version of the formula that make up MACD, the 12-day EMA is called the fast period and the 26-day EMA is called the slow period. The daily closes are used in the exponential moving average calculation. Traditionally, a 9-day EMA of the MACD value itself is plotted along side to act as a signal line. A bullish crossover occurs when MACD moves above the signal line and a bearish crossover occurs when MACD moves below the signal line. The histogram represents the difference between MACD and its signal line. The histogram is positive when MACD is above the signal line and negative when MACD is below the signal line. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing and this would be considered bullish. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating and this would be considered bearish. MACD Histogram values are a useful way of pictorializing the key components of the MACD indicator. The MACD value represent the differences between the two moving averages that are discussed in connection with the MACD indicator and in turn we can trace the difference between this value and the signal line that is a smoothed version of this difference amount. This seconday value can then be plotted on a histogram allowing a ueful monitoring of the evolution of the primary indicator with respect to the signal line. Taken on its own the histogram value has little value but when one looks at the histogram itself over time or when the value reaches a threshold point there can be useful information provided. When the histogram value falls below the zero line this is indicating that the MACD has fallen below the signal line. Crossovers can be significant but only when there is other supporting evidence from the pattern analysis. One of our preferred ways to interpret the MACD indicator is to look for divergences between the shape of the MACD chart formation and the shape of the price formation. Again this type of divergence may not be a reliable indicator on its own but when it coincides with money flow divergences and RSI divergences it becomes increasingly useful as a technical analysis tool. The Money Flow Index is a volume-weighted version of the Relative Strength Index. The indicator compares the total transaction values traded on days with upward price movement to the transactions value traded on days with downward price movement. The following is the method for calculating the Money Flow Index
Money Flow Divergence is a proprietary indicator (that is still undergoing refinement) which creates a numerical value to reflect divergences between the money flow activity for a security and the price activity. What is important in this indicator is not so much to look for extreme values in either direction, but rather to look for situations that may be emerging. For example if the MFI value is above 60 but the Money Flow Divergence value is a negative amount, perhaps -30, this could represent the beginning of a pattern of divergence. In itself the Money Flow Divergence value should not be relied upon as it often contains money flow information that is already reflected in either higher or lower prices. When taken in conjunction with other values, and as pointed out when it is beginning to diverge from the underlying MFI scenario, it may provide early clues as to an emerging pattern. The Morning Star candlestick formation is a three day bullish reversal pattern. The first day is in a downtrend with a long red real body. The following day gaps lower and has a small real body. The last day is a green candlestick that closes above the midpoint of the first session's red real body. DOJI CANDLESTICK ALSO NARROWEST RANGE IN SEVEN SESSIONS Price formation that shows a doji candlestick and also the narrowest range seen in the preceding seven sessions. OBV is a simple cumulative measure of the volume of a security, developed by Joseph Granville in the 1960’s. The formula for calculating OBV is remarkably simple:
OBV has been very influential in helping technical analysts to appreciate the usefulness of indicators that point to divergences, as Granville used OBV to look for situations where positive price development was not supported by increases in OBV. The Price Change field used in the Patterns Analysis tables represents the change between the current closing price and a previous closing price using as an offset the value contained within the parentheses. For example, Price Chg(1) will return the change between today's close and yesterday's close, and Price Chg(3) would reflect the change between the current close and the close from three periods ago. QUANTILE COMPARATIVE ANALYSIS [QCA] This is a technique which is featured in Clive Corcoran's bool Long/Short Market Dynamics (Wiley 2007) . Expressed in simple form, QCA rests on the view that markets are most revealing when they stray from the norm. For example in relation to volume, the quieter (low volume) sessions and the more active (high volume) sessions are usually more revealing than the sessions when there is more typical volume. With this in mind it is proposed that each market metric should be thought of as being best represented as a continuum or spectrum of values and that the value recorded for each session should be situated in that spectrum’s range. Once such a continuum is assumed it becomes feasible to identify which segment of the spectrum each daily position occupies. There is a commonly used term within statistics that is applicable to the situation just described – a quantile. A quantile is a generic term that covers some better known specific instances which includes percentiles and deciles. The central idea behind quantiles in general is that data is ranked (i.e. sorted from lowest to highest) and then, depending on which quantile one is interested in, for example, the lower decile, the relevant quantile value can be identified from looking at the data values that lie within the appropriate interval. If one is focusing on the lower decile then one would be interested in the value that represents the demarcation point that separates out the lowest ten percent of the values. With this framework it becomes possible to identify divergences based upon examining where two market metrics lie in relation to their specific quantiles. For example, if it is found that (say) within the last 20 periods the closing price has been within its upper quartile for 15 sessions and the closing bias has been within its lower quartile for 12 sessions, there is evidence of a form of dissonant behavior which is pointing to the need for some resolution of this conflict. This very popular technical analysis tool was introduced by J. Welles Wilder in his 1978 book, New Concepts in Technical Trading Systems. The RSI compares the magnitude of a stock's recent gains to the magnitude of its recent losses and quantifies those relative magnitudes by means of an index number that ranges from 0 to 100.The formula takes a single parameter, the number of time periods to use in the calculation, or the lookback window. In his book, Wilder recommended using a 14 period time window but we have found that 10 periods better serves our purposes. The steps in calculation of the Relative Strength Index are:
The Shooting Star candlestick is a bearish pattern where the stock opens higher, trades still higher creating a long upper shadow and then the stock closes at or near the lows for the day. The candle body is relatively small and there should be either no lower shadow or a very small one. The Spinning Top candlestick formation has a relatively small candle body that can be of either color and this is accompanied by both upper and lower shadows or tails that are longer than the body width. Spinning Tops are often found at pivotal points and inflections and can indicate indecision or anticipation prior to significant market moves. Trend days are ones where trading is largely uni-directional with very little anti-trend behaviour. Usual rejection at resistance levels or accommodation at support levels may be entirely absent during the session. Market reveals short term illiquidity – absence of opposition to the prevailing trend or mood of the session, and there is an expansion from the recent trading range. The opening price will be near to the low for an up trend day and the close will be near to the high for a down trend day. In essence, the closing price will be near to the extreme intraday value registered in the direction of the trend. True Range is a more useful way of measuring range - rather than simple subtracting the session low from the session high - especially in volatile periods where stocks are experiencing “gaps”. Commodities markets can have large gaps and limit moves. A limit move occurs when a price opens up or down its maximum allowed daily move – and no trading will take place, unless price moves back within permissible range. The True Range is the greater value of the following:
The Volume Multiplier value that is used in the Patterns Analysis tables is the ratio of the volume during the current session to the simple average daily volume during the 15 preceding sessions. |