Market Indicators

Indicators are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum.

Indicators are used as a secondary measure to the actual price movements and add additional information to the analysis of securities.

Market Indicators

Indicators are used in two main ways:

• to confirm price movement, and • to form buy and sell signals. 

Market IndicatorsThese indicators help identify:

• momentum, • trends, • volatility, and • various other aspects in a security to aid in

the technical analysis of trends.

Indicators are best used in conjunction with price movement, chart patterns and other indicators. 

Market Indicators: Breadth IndicatorsThe Advance-Decline Line: The advance-decline line is also referred to as the breadth of the market.

Its measurement involves two steps:Step1: Calculate the number of net advances / declines on a daily basis.

Step2: Obtain the breadth of the market of the market.

Indication: If the market average is moving upwards, whereas the breadth of market is moving downwards, it indicates that the market is likely to turn bearish.

Market Indicators: Breadth IndicatorsThe Advance-Decline Line

Day Advances Declines Net Advances or Declines

Breadth of Market

Tuesday 630 527 103 (630-527) 103

Wednesday

690 475 215 (690-475) 318 (103+215)

Thursday 746 424 322 (746-424) 640 (318+322)

Friday 492 630 -138 (492-630) 502 (640-138)

Monday 366 701 -335 (366-701) 167 (502-335)

Tuesday 404 698 - 294 (404-698) -127 (167-294)

Market Indicators: Sentiment IndicatorShort-Interest Ratio: The short interest in a security is simply the number of shares that have been sold short but not yet brought back.

Investors sell short when they expect the prices to fall. So when the short interest ratio is high it means that most investors expect the price to fall.

Total number of shares sold shortShort Interest Ratio= ----------------------------------------------

Average daily trading volume

Market Indicators: Sentiment IndicatorMutual Fund Liquidity: According to the theory of contrary opinion, it makes sense to go against the crowd because the crowd is generally wrong.

Based on this theory, mutual fund liquidity has been developed.

If MFL is low, it means that the mutual funds are bullish. So, contrarians argue that the market is at the peak & hence is likely to decline. Thus, low MFL is considered as a bearish indicator & vice-versa.

Market Indicators: Sentiment IndicatorPut / Call Ratio: Speculators buy calls when they are bullish and buy puts when they are bearish. Since speculators are often wrong, some technical analysts consider the put/call ratio as a useful indicator.

Number of puts purchasedPut / Call Ratio= ------------------------------------------

Number of calls purchased

Market Indicators: Sentiment IndicatorExample: A ratio of 0.70 means that only 7 puts are purchased for very 10 calls purchased.

A rise in the put/call ratio indicates that the speculators are pessimistic. For the contrarians, this is a buy signal as they believe that the speculators are generally wrong.

Conversely when the put/call ratio falls, it means that the speculators are optimistic. The contrarian regards this as a sell signal.

Market Indicators: Sentiment IndicatorTrin Statistic: Market volume may be used to judge the strength of a market rise or fall. Technical analysts regard advances as more bullish if they are accompanied with increased trading volume. Likewise, they consider declines as more bearish when accompanied with increased trading volume.

Number advancing / number decliningTrin = ------------------------------------------------------

Volume advancing / volume declining

Market Indicators: Sentiment Indicator

Generally, a trin ratio of more than 1 is deemed bearish as it means that the declining stocks have higher average volume compared to advancing stocks, suggesting a net selling pressure.

Moving Average AnalysisThere are a number of different types of moving averages that vary in the way they are calculated, but how each average is interpreted remains the same.

The calculations only differ in regards to the weighting that they place on the price data, shifting from equal weighting of each price point to more weight being placed on recent data.

 

Moving Average AnalysisThe three most common types of moving averages are:

1. Simple Moving Average

2. Linear Moving Average

3. Exponential Moving Average

Simple Moving AverageThis is the most common method used to calculate the moving average of prices.

It simply takes the sum of all of the past closing prices over the time period and divides the result by the number of prices used in the calculation.

For example, in a 10-day moving average, the last 10 closing prices are added together and then divided by 10.

Simple Moving Average

A trader is able to make the average less responsive to changing prices by increasing the number of periods used in the calculation.

Increasing the number of time periods in the calculation is one of the best ways to gauge the strength of the long-term trend and the likelihood that it will reverse.

 

Simple Moving Average

Linear Moving Average

This moving average indicator is the least common out of the three and is used to address the problem of the equal weighting.

The linear weighted moving average is calculated by taking the sum of all the closing prices over a certain time period and multiplying them by the position of the data point and then dividing by the sum of the number of periods.

Linear Moving Average

Example, in a five-day linear weighted average, today's closing price is multiplied by five, yesterday's by four and so on until the first day in the period range is reached. These numbers are then added together and divided by the sum of the multipliers. 

Exponential Moving AverageThis moving average calculation uses a smoothing factor to place a higher weight on recent data points and is regarded as much more efficient than the linear weighted average.

Having an understanding of the calculation is not generally required for most traders because most charting packages do the calculation for you.

Exponential Moving AverageThe exponential moving average is more responsive to new information relative to the simple moving average.

This responsiveness is one of the key factors of why this is the moving average of choice among many technical traders.

A 15-period EMA rises and falls faster than a 15-period SMA. This slight difference doesn’t seem like much, but it is an important factor to be aware of since it can affect returns. 

Exponential Moving Average

Moving Average

What do the different days mean?

20 days - choppy line. It isn't the most accurate, but is probably the most useful for short term traders.

30 day - similar to 20 day but provides a bit more certainty for the trend.

50 day - moving averages provide a much less volatile, smooth line. This can be used to detect somewhat longer term trends.

Moving Average

100 day - similar to the 50 day, it is less volatile, and one of the most widely used for long term trends.

200 day - even less volatile, more of a rolling chart or smooth line. It doesn't react to quick movements in the stock price therefore it is rarely used.

Strategies for Moving Averages• Crossovers

Several different types of crossover's, but all of them involve two or more moving averages.

• In a double crossover you are looking for a situation where the shortest MA crosses through the longer one. This is almost always considered to be a buying signal since the longer average is somewhat of a support level for the stock price.

• For extra insurance you can use a triple crossover, whereby the shortest moving average must pass through the two higher ones. This is considered to be an even stronger buying indicator.

Strategies for Moving Averages• Filters

Used to increase confidence about an indicator

• No set rules or things to look out for when filtering, just whatever makes you confident enough to invest your money. Example: one might want to wait until a security crosses through its moving average and is at least 10% above the average to make sure that it is a true crossover.

–Remember, setting the percentile too high could result in "missing the boat" and buying the stock at its peak.

Strategies for Moving Averages

• Filters

Another filter is to wait a day or two after the security crosses over, this can be used to make sure that the rise in the security isn't a fluke or unsustained.

–Again, the downside is if you wait too

long then you could end up missing some big profits.

MACD

A variation of the moving average is the moving average convergence divergence or MACD.

It involves comparing a short term moving average (a 50 day moving average) with a long term moving average (a 200 day moving average).

MACD

If the short term moving average is consistently higher than the long term moving average, it is a bullish signal.

If the short term moving average is consistently lower than the term moving average, it is a bearish signal.

Relative Strength Analysis

The relative strength analysis is based on the assumption that prices of some securities rise rapidly during the bull phase but fall slowly during the bear phase in relation to the market as a whole.

In other words, some securities possess greater relative strength and hence outperform the market.

Relative Strength AnalysisRSI also helps to signal overbought and oversold conditions in a security. The indicator is plotted in a range between zero and 100. A reading above 70 is used to suggest that a security is overbought, while a reading below 30 is used to suggest that it is oversold. This indicator helps traders to identify whether a security’s price has been unreasonably pushed to current levels and whether a reversal may be on the way. 

Relative Strength Analysis

Relative Strength Analysis

The standard calculation for RSI uses 14 trading days as the basis, which can be adjusted to meet the needs of the user. If the trading period is adjusted to use fewer days, the RSI will be more volatile and will be used for shorter term trades.