Technical Indicators - smueye.wdfiles.comsmueye.wdfiles.com/local--files/research-meetings/8 - TA Lesson 5... · Technical Analysis of the Financial Markets A Comprehensive Guide

Technical Indicators

Taken From:

Technical Analysis of the Financial Markets

A Comprehensive Guide to Trading Methods & Applications

John Murphy, New York Institute of Finance, Published 1999


SMU E.y.E Investment Interactive Club

Technical IndicatorsTechnical indicators look to predict the future price levels, or simply the general price direction, of a security by looking at past patterns 1

1 http://www.investopedia.com/terms/t/technicalindicator.asp

http://www.investopedia.com/terms/t/technicalindicator.asp

http://www.investopedia.com/terms/t/technicalindicator.asp



Types of indicatorsMarket Strength

Advance Decline LineOpen Interest

VIX

Momentum

Moving averagesMACDParabolic SARRate of change

Oscillators

StochasticsRSI

Volume

OBV



General rules to indicators1. Use the indicator for its designed purpose

2. There are times when some indicators are more useful than others

3. Use indicators in conjunction with other information such as price and volume

4. Time frame in line with your investment style



Market Strength IndicatorsTo determine the health of the overall stock market by

measuring market breadth

To indicate the broadness of a rally or decline

Helps the technician who uses a top-down approach in stock market analysis

A rising tide lifts all boats and a falling tide sinks all boats



Advance Decline LineBest known of breadth indicators

Calculates the difference between declining and advancing issues

A/D Line = (# of Advancing Stocks - # of Declining Stocks) + Previous Period's A/D Line Value


Using the AD Line

Trend following

AD line and the market averages are trending in the same direction as confirmation of trend

Divergence

Red flag when broader market (AD) does not follow the index movements.

Historically AD line peaks ahead of market averages


AD line examplehttp://stibreadth.blogspot.com/

Divergence Trend following

http://stibreadth.blogspot.com

http://stibreadth.blogspot.com


VIX - CBOE Volatility IndexConstructed using the implied volatilities of a wide rangeof S&P 500 options

Popular gauge of fear in investors



Using the VIX

Reading of 20 - 25%

Investor complacency

Market to continue moving in the same direction

Reading of > 25 - 30%

Investor fear

Market turnaround


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Sources for market strength indicators

AD LineSingapore: stibreadth.blogspot.comNYSE: Wall Street Journal, Investor’s business daily

VIXS&P 500: Yahoo finance ticker ^VIX




Average Directional IndexADX

Gauge of strength of prevailing trend

Does not determine the direction of trend

Ranges from 0 to 100, but rarely above 60



Using ADXADX > 30

Indicates strong trend

ADX < 20

Weak trend

Confirm with low volumes

ADX > 40

Trend likely to weaken imminently

Watch for ADX to form a top and retrace to the MA

Action

Enter on breakout of trendline, MA or price pattern

Price basing action, draw support or resistances

ADX exampleKS Energy



Momentum IndicatorsAs a guide to whether an uptrend or downtrend is sustained

Indicates the strength of the trend

Helps to spot overbought and oversold levels

Momentum precedes price



Caveat to momentum indicators

Prices can decline on falling momentum

Momentum indicators are secondary to price and volume

Momentum indicators most useful in trending markets



Rate of ChangeRate of change = Previous close / Close x days ago

Zero as an important level

Construction of formula may vary



Using Rate of Change

Entering the market1. Confirm trending

2. Enter in direction of trend when ROC crosses zero

Exiting the market

Exit after rapid increase or decrease in ROC

When ROC crosses zero

or

ROC exampleDBS

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ROC exampleSingtel



Moving Average ConvergenceDivergence - MACD

Shows acceleration and deceleration of trend

Helps to spot major trend reversal

Has both moving averages and rate of change elements(lagging and leading)



Elements of MACD

Blue: MACD (short EMA - long EMA) Red : EMA of MACD Histogram: Difference between MACD and signal line



Using MACDConfirmation of reversal

1. MACD cutting its signal lineReversal of momentum

2. MACD cutting the zero lineReversal of trend

Spotting divergence or confirming convergence

1. MACD cutting its signal lineReversal of momentum

2. MACD cutting the zero lineReversal of trend

MACD exampleCosco

MACD exampleSTI

Monday, 7 Jan 2008

MACD exampleChina Aviation Oil



OscillatorsExtremely useful in a nontrending market

Identify short term market extremes

Signal divergence



Relative strength index

RSI = 100 - 100/(1+RS) RS = Average of x daysʼ up closes / Average of x daysʼ down closes

Shorter the time period, the more sensitive the oscillator

RSI exampleChartered Semicon

RSI exampleChartered Semicon

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RSI example

Practice Time

• Capitaland – Daily– 2006– MACD

• Raffles Education– Daily– 2007– RSI & ADX

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Technical Indicators - smueye.wdfiles.comsmueye.wdfiles.com/local--files/research-meetings/8 - TA Lesson 5... · Technical Analysis of the Financial Markets A Comprehensive Guide