Parabolic SAR 116

• If tomorrow's SAR value lies within (or beyond) tomorrow's price range, a new trend direction is then signaled,
and the SAR must "switch sides."
Upon a trend switch, several things happen. The first SAR value for this new trend is set to the last EP recorded on
the previous trend. The EP is then reset accordingly to this period's maximum. The acceleration factor is reset to its
initial value of 0.02.

External links
• Using Parabolic SAR for Buy and Sell signals, and placing Stop Loss orders [1]
• How to Trade Parabolic SAR - InformedTrades [2]
• Yahoo! Finance Charts User Guide [3]

References
• J. Welles Wilder, Jr. (June 1978). New Concepts in Technical Trading Systems. Greensboro, NC: Trend Research.
ISBN 978-0894590276.

References
[1] http:/ / www. onlinetradingconcepts. com/ TechnicalAnalysis/ ParabolicSAR. html
[2] http:/ / www. informedtrades. com/ 4559-how-trade-parabolic-sar-forex-futures-stocks. html
[3] http:/ / biz. yahoo. com/ charts/ guide16. html

Trix (technical analysis)

Trix (or TRIX) is a technical analysis oscillator developed in the 1980s by Jack Hutson, editor of Technical
Analysis of Stocks and Commodities magazine. It shows the slope (i.e. derivative) of a triple-smoothed exponential
moving average. The name Trix is from "triple exponential."
Trix is calculated with a given N-day period as follows:
• Smooth prices (often closing prices) using an N-day exponential moving average (EMA).
• Smooth that series using another N-day EMA.
• Smooth a third time, using a further N-day EMA.
• Calculate the percentage difference between today's and yesterday's value in that final smoothed series.
Like any moving average, the triple EMA is just a smoothing of price data and therefore is trend-following. A rising
or falling line is an uptrend or downtrend and Trix shows the slope of that line, so it's positive for a steady uptrend,
negative for a downtrend, and a crossing through zero is a trend-change, i.e. a peak or trough in the underlying
average.
The triple-smoothed EMA is very different from a plain EMA. In a plain EMA the latest few days dominate and the
EMA follows recent prices quite closely; however, applying it three times results in weightings spread much more
broadly, and the weights for the latest few days are in fact smaller than those of days further past. The following
graph shows the weightings for an N=10 triple EMA (most recent days at the left):
Trix (technical analysis) 117

Note that the distribution's mode will

lie with pN-2's weight, i.e. in the graph
above p8 carries the highest weighting.
An N of 1 is invalid.

Triple exponential moving average weightings, N=10 (percentage versus days ago)

The easiest way to calculate the triple EMA based on successive values is just to apply the EMA three times,
creating single-, then double-, then triple-smoothed series. The triple EMA can also be expressed directly in terms of
the prices as below, with today's close, yesterday's, etc., and with (as for a

plain EMA):

The coefficients are the triangle numbers, n(n+1)/2. In theory, the sum is infinite, using all past data, but as f is less
than 1 the powers become smaller as the series progresses, and they decrease faster than the coefficients
increase, so beyond a certain point the terms are negligible.

References
• StockCharts.com article on TRIX [1], by Nicholas Fisher

References
[1] http:/ / stockcharts. com/ education/ IndicatorAnalysis/ indic_trix. htm
Vortex Indicator 118

Vortex Indicator
The Vortex Indicator is a technical indicator invented by Etienne Botes and Douglas Siepman to identify the start
of a new trend or the continuation of an existing trend within financial markets. It was published in the January 2010
edition of Technical Analysis of Stocks & Commodities.[1]

Inspiration
The Vortex Indicator was inspired by the work of an Austrian inventor, Viktor Schauberger, who studied the flow of
water in rivers and turbines. Etienne Botes and Douglas Siepman developed the idea that movements and flows
within financial markets are similar to the vortex motions found in water. The Vortex Indicator was also partly
inspired by J. Welles Wilder's concept of directional movement, which assumes the relationship between price bars
gives clues as to the direction of a market.[2]

Description
A vortex pattern may be observed in any market by connecting the lows of that market’s price bars with the
consecutive bars’ highs, and then price bar highs with consecutive lows. The greater the distance between the low of
a price bar and the subsequent bar’s high, the greater the upward or positive Vortex movement (VM+). Similarly, the
greater the distance between a price bar’s high and the subsequent bar’s low, the greater the downward or negative
Vortex movement (VM-).

A Vortex Pattern in the Market: By connecting the lows of price bars with the consecutive bars’ highs, and then price bar highs with consecutive
lows, one can observe a vortex pattern in the market.

The Vortex Indicator: The greater the distance between the low of a price bar and the subsequent bar’s high, the stronger the positive Vortex
movement (VM+). Similarly, the greater the distance between a price bar’s high and the subsequent bar’s low, the stronger the negative Vortex
movement (VM-).
Vortex Indicator 119

Identifying a trend
On a chart, VI+ and VI- will be seen to intersect each other at a change of trend, and begin to diverge ever wider as
the strength of a trend increases. When VI+ is larger and above VI-, the market is trending up. Conversely, when VI-
is bigger and above VI+, the market is trending down.
A trader should focus on the key trend change points of the Vortex Indicator (i.e. the crossing points of VI+ and
VI-). When VI+ crosses above VI-, a long (buy) position is indicated. A short or sell position is suggested when VI-
crosses above VI+.
The published article also suggested further measures to ensure an effective trading strategy, for example, only
entering a trade at the extreme high or low of the price bar that corresponds with a crossing of the Vortex
Indicator.[3]

14-Period Daily Vortex Indicator: When VI+ is greater than VI-, it indicates that the market is trending up. The market is trending down when
VI- is above VI+. The potential change of trend points are found where VI+ and VI- intersect one another.

Price Chart: As the trend strengthens, notice how the VI+ and VI- lines increasingly diverge. As the trend weakens, you will observe the two lines
converging again.

Calculation
The high, low and close values are required for any chosen stock, future, commodity or currency. These values may
be 15-minute, hourly, daily, etc.
• First, calculate the current True Range:
• Current True Range (TR) = Maximum absolute value of either (Current High-Current Low), (Current
Low-Previous Close), (Current High-Previous Close)
• Next, calculate the current upward (positive) and downward (negative) Vortex movements:
• Current Vortex Movement Up (VM+) = Absolute value of Current High – Previous Low
• Current Vortex Movement Down (VM-) = Absolute Value of Current Low – Previous High
Vortex Indicator 120

• Decide on a parameter length (21 periods was used for this example). Now, sum the last 21 period’s True
Range, VM+ and VM-:
• Sum of the last 21 periods’ True Range = SUM TR21
• Sum of the last 21 periods’ VM+ = SUM VM21+
• Sum of the last 21 periods’ VM- = SUM VM21-
• Finally, divide SUM VM21+ and SUM VM21- respectively with the SUM TR21 to obtain the Vortex
Indicator:
• SUM VM21+/SUM TR21 = VI21+
• SUM VM21-/SUM TR21 = VI21-
If this process is repeated, the resulting VI21+ and VI21- can be drawn graphically to represent the two lines of the
Vortex Indicator.

Practical application
The Vortex Indicator is simple to use as the only required inputs are the high, low and close of a price bar. Traders
may use the Vortex Indicator on its own, in combination with other technical indicators to confirm a change of trend
or as part of a larger trading system.
In addition, the Vortex Indicator may be used for any:
• market (such as stocks, futures or currencies)
• time frame (for example, 15 minute, hourly or weekly charts)
• parameter (such as 13, 21 or 34 periods)
The inventors of the Vortex Indicator recommend using longer time frames and parameters in order to filter out false
signals. If a trader does opt to use a very short time frame, such as 5 minutes, this should be combined with a long
parameter of 34 or 55 periods.
Because of its universal applicability, the Vortex Indicator is suitable for both short term traders as well as longer
term fund managers who may wish to identify larger macro trends within a market.

Coding and strategies

The Vortex Indicator is available on most charting software.[4] Some of these companies have suggested additional
trading strategies to use in conjunction with the Vortex Indicator, including the implementation of a trailing stop [5]
and making use of supporting indicators in order to reduce the number of false signals.[6]

Comparative studies
To test the Vortex Indicator against Welles Wilder’s Directional Movement Indicator (DMI), a portfolio of 38 of the
most actively traded, full sized, futures contracts was created. These 38 futures included a number of index and
financial futures, currencies, metals, energy futures and commodities like grains, oils and foods. The test period was
from 3 January 1978 to 6 November 2009, using a 14 day parameter for both indicators. Over the entire test period,
and also during the last 10 years, the Vortex Indicator showed a better performance than the DMI.[7]
However, using a similar test based on 101 NASDAQ stocks, on a smaller sample (for the period 2 January 1992 to
14 August 2009), the DMI showed a better performance than the Vortex Indicator.[8]
Vortex Indicator 121

Possible improvement and variation

An alternative version of the indicator was created by Jez Liberty.[9] This version enables the calculation to account
for gap days which sometimes occur in non-continuous markets such as stocks.[10]

References
[1] Botes, Etienne & Siepman, Douglas (January 2010). “The Vortex Indicator”. Technical Analysis of Stocks & Commodities 28(1), p. 21.
[2] Wilder, J. Welles (1978). New Concepts In Technical Trading Systems. Trend Research.
[3] Botes, Etienne & Siepman, Douglas (January 2010). “The Vortex Indicator”. Technical Analysis of Stocks & Commodities 28(1), p. 25.
[4] "Traders’ Tips" (http:/ / www. traders. com/ Documentation/ FEEDbk_docs/ 2010/ 01/ TradersTips. html). Technical Analysis of Stocks &
Commodities. January 2010. . Retrieved 17 January 2010.
[5] Mills, Mark (January 2010). "TRADESTATION: VORTEX INDICATOR" (http:/ / www. traders. com/ Documentation/ FEEDbk_docs/
2010/ 01/ TradersTips. html). TradeStation Securities, Inc. . Retrieved 17 January 2010.
[6] Rast, Pete (January 2010). "STRATASEARCH: VORTEX INDICATOR" (http:/ / www. traders. com/ Documentation/ FEEDbk_docs/ 2010/
01/ TradersTips. html). Avarin Systems, Inc. . Retrieved 17 January 2010.
[7] Denning, Richard (January 2010). "January 2010 Stocks and Commodities Traders Tips" (http:/ / www. tradersedgesystems. com/ aiq/
traderstips/ traders-tips-january-2010. htm). Traders Edge Systems. . Retrieved 17 January 2010.
[8] Denning, Richard (January 2010). "January 2010 Stocks and Commodities Traders Tips" (http:/ / www. tradersedgesystems. com/ aiq/
traderstips/ traders-tips-january-2010. htm). Traders Edge Systems. . Retrieved 17 January 2010.
[9] Liberty, Jez (April 2010). “Vortex Indicator In Trading Blox”. Technical Analysis of Stocks & Commodities 28(5), p. 76.
[10] Liberty, Jez (February 2010). "Vortex indicator" (http:/ / www. automated-trading-system. com/ free-code-improved-vortex/ ). Automated
Trading System. . Retrieved 11 November 2010.

External links
• The Vortex Indicator (http://www.traders.com/Reprints/PDF_reprints/VFX_VORTEX.PDF)

Know Sure Thing (KST) Oscillator

Know Sure Thing (KST) Oscillator is a complex, smoothed price velocity indicator developed by Martin J. Pring.[1]
[2]

Rate of Change (ROC) indicator is the foundation of KST indicator. KST indicator is useful to identify major stock
market cycle junctures because it formula is weighed to have larger influence by the longer and more dominant time
span to better reflecting the primary swings of stock market cycle.[3] . The concept behind the oscillator is that price
trends are determined by the interaction of many different time cycles and that important trend reversals take place
when a number of price trends are simultaneously changing direction.

Formula
Four different rates of change are calculated, smoothed, multiplied by weights and then summed to form one
indicator.[4]

Where Price refers to current closing price and Price(X1) refers to the closing price X1 bars ago.

Where MOV(ROC1,AVG1) refers to the AVG1 day moving average for ROC1
For Short term trend, Martin J Pring suggest the following parameters:
Know Sure Thing (KST) Oscillator 122

X1 = 10
X2 = 15
X3 = 20
X4 = 30
AVG1 = 10
AVG2 = 10
AVG3 = 10
AVG4 = 15
W1 = 1
W2 = 2
W3 = 3
W4 = 4
The formula is built into, or can be included into various technical analysis softwares like MetaStock[5] or
OmniTrader[6] .

Implications

Entry rules KST Indicator

When KST crosses below its 8 day exponential average, short at the next day opening price.

Exit rules KST Indicator

When KST crosses above its 8 day exponential average, close short position at the next day opening price.[4]

Variations
It can be calculated on daily[7] or long term[8] basis.
The dominant time frame in the Know Sure Thing (KST)'s construction is a 24-month period, which is half of the
4-year business cycle. This means that the Know Sure Thing (KST) will work best when the security in question is
experiencing a primary up- and downtrend based on the business cycle.[4]

KST Interpretation
KST can be interpreted in the ways mentioned below.[7]
The dominant time frame in the Know Sure Thing (KST)'s construction is a 24-month period, which is half of the
4-year business cycle. This means that the Know Sure Thing (KST) will work best when the security in question is
experiencing a primary up- and downtrend based on the business cycle.

Directional Changes and Moving Average Crossovers

You’ve discovered how changes in direction are the way the KST triggers signals, but also that moving average
crossovers offer less timely, but more reliable signals. The average to use is a simple 10-day moving average. It is
possible to anticipate a moving average crossover if the KST has already turned and the price violates a trendline.
The KST started to reverse to the downside before the up trendline was violated. Since either a reversal or a trading
range follow a valid trendline violation, it’s evident that upside momentum has temporarily dissipated, causing the
KST to cross below its moving average.
Know Sure Thing (KST) Oscillator 123

Traditionally, the MACD gives buy and sell signals when it crosses above and below its exponential moving
average, known as the “signal line”. This approach isn’t perfect; the ellipses on the chart highlight all the whipsaws.
As said earlier, the KST can also give false or misleading signals, as you can see from the April 2005 buy signal. It
comes close to a couple of whipsaws, but by and large, it’s more accurate, even though the MACD often turns faster
than the KST.

Overbought/Oversold and Divergences

The concept is that when the indicator crosses above and below the overbought/oversold zones, momentum buy and
sell signals are triggered. Even so, you must wait for some kind of trend reversal signal in the price, such as a price
pattern completion, trendline violation, or similar.
The KST often diverges positively and negatively with the price.

Trendline Violations and Price Pattern Completions

It is possible to construct a trendline on the KST and see when it’s been violated, but not very often. When it does
though, it usually results in a powerful signal.

References
[1] Martin J. Pring (1991). Technical Analysis Explained (3rd ed.). McGraw/Hill.
[2] Robert W. Colby (2003). The encyclopedia of technical market indicators (http:/ / books. google. co. in/ books?id=SYWkGQawUgAC&
pg=PA346& lpg=PA346& dq=Know+ Sure+ Thing+ (KST)+ Oscillator& source=bl& ots=I0INaZylU8&
sig=yuqDNjXlMtKT09UcjsepYmO4CQg& hl=en& ei=VMPaTM2ABI2UvAO2hej2CQ& sa=X& oi=book_result& ct=result& resnum=2&
ved=0CCMQ6AEwAQ#v=onepage& q& f=false). McGraw-Hill Professional. p. 346. . Retrieved 2010-11-10.
[3] "Technical Analysis - Online Know Sure Thing (KST) Indicator Lessons" (http:/ / www. 1technicalanalysis. com/ momentum-indicators/
KST-know-sure-thing/ online-know-sure-thing-lessons. php). . Retrieved 2010-11-10.
[4] "KST( Know sure thing ) indicator in stock market" (http:/ / abc-stock-market. blogspot. com/ 2009/ 06/
kst-know-sure-thing-indicator-in-stock. html). http:/ / abc-stock-market. blogspot. com. . Retrieved 2010-11-10.
[5] "KST Oscillator : Martin Prings formula" (http:/ / forum. esignalcentral. com/ showthread. php?threadid=29167). eSignal. . Retrieved
2010-11-10.
[6] "Nirvana Pring KST Package Plug-in" (http:/ / www. omnitrader. com/ omnitrader/ products/ OT/ plugins/ KST. asp). OmniTrader. .
Retrieved 2010-11-10.
[7] Martin J. Pring. "Introducing the Daily KST" (http:/ / www. pring. com/ movieweb/ daily_kst. htm). pring.com. . Retrieved 2010-11-10.
[8] Martin J. Pring. "Long-term KST" (http:/ / www. pring. com/ articles/ article28. htm). pring.com. . Retrieved 2010-11-10.
 124

INDICATORS: Momentum

Momentum (finance)
In finance, momentum is the empirically observed tendency for rising asset prices to rise further. For instance, it
was shown that stocks with strong past performance continue to outperform stocks with poor past performance in the
next period with an average excess return of about 1% per month (Jegadeesh and Titman, 1993, 1999).
The existence of momentum is a market anomaly, which finance theory struggles to explain. The difficulty is that an
increase in asset prices, in and of itself, should not warrant further increase. Such increase, according to the
efficient-market hypothesis, is warranted only by changes in demand and supply or new information (cf.
fundamental analysis). Students of financial economics have largely attributed the appearance of momentum to
cognitive biases, which belong in the realm of behavioral economics. The explanation is that investors are irrational
(Daniel, Hirschleifer, and Subrahmanyam, 1998 and Barberis, Shleifer, and Vishny, 1998), in that they underreact to
new information by failing to incorporate news in their transaction prices. However, much as in the case of price
bubbles, recent research has argued that momentum can be observed even with perfectly rational traders (Crombez,
2001).

References
• Barberis, N., A. Shleifer, and R. Vishny. “A Model of Investor Sentiment.” Journal of Financial Economics, 49,
1998.
• Crombez, J. "Momentum, Rational Agents and Efficient Markets." The Journal of Psychology and Financial
Markets, 2, 2001.
• Daniel, K., D. Hirschleifer, and A. Subrahmanyam. “A Theory of Overconfidence, Self-Attribution, and Security
Market Under and Over-reactions.” Journal of Finance, 53, 1998.
• Jegadeesh, N., and S. Titman. “Returns to Buying Winners and Selling Losers: Implications for Stock Market
Efficiency.” Journal of Finance, 48, 1993.
• Jegadeesh, N., and S. Titman. “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations.”
NBER Working paper #7159, 1999.
Relative Strength Index 125

Relative Strength Index

The Relative Strength Index (RSI) is a technical indicator used in the technical analysis of financial markets. It is
intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a
recent trading period. The indicator should not be confused with relative strength.
The RSI is classified as a momentum oscillator, measuring the velocity and magnitude of directional price
movements. Momentum is the rate of the rise or fall in price. The RSI computes momentum as the ratio of higher
closes to lower closes: stocks which have had more or stronger positive changes have a higher RSI than stocks which
have had more or stronger negative changes.
The RSI is most typically used on a 14 day timeframe, measured on a scale from 0 to 100, with high and low levels
marked at 70 and 30, respectively. Shorter or longer timeframes are used for alternately shorter or longer outlooks.
More extreme high and low levels—80 and 20, or 90 and 10—occur less frequently but indicate stronger
momentum.
The Relative Strength Index was developed by J. Welles Wilder and published in a 1978 book, New Concepts in
Technical Trading Systems, and in Commodities magazine (now Futures magazine) in the June 1978 issue.[1]

Calculation
For each trading period an upward change U or downward change D is calculated. Up periods are characterized by
the close being higher than the previous close:

Conversely, a down period is characterized by the close being lower than the previous period's (note that D is
nonetheless a positive number),

If the last close is the same as the previous, both U and D are zero. The average U and D are calculated using an
n-period exponential moving average (EMA). The ratio of these averages is the Relative Strength:

If the average of D values is zero, then the RSI value is defined as 100.
The Relative Strength is then converted to a Relative Strength Index between 0 and 100:

The exponential moving averages should be appropriately initialized with a simple averages using the first n values
in the price series.
Relative Strength Index 126

Interpretation

Basic configuration
The RSI is presented on a graph above
or below the price chart. The indicator
has an upper line, typically at 70, a
lower line at 30, and a dashed mid-line
at 50. Wilder recommended a
smoothing period of 14 (see EMA
smoothing, i.e. α = 1/14 or N = 27).

Principles
Wilder posited that when price moves
up very rapidly, at some point it is
considered overbought. Likewise,
when price falls very rapidly, at some
Relative Strength Index 14-period
point it is considered oversold. In
either case, Wilder deemed a reaction
or reversal imminent.
The level of the RSI is a measure of the stock's recent trading strength. The slope of the RSI is directly proportional
to the velocity of a change in the trend. The distance traveled by the RSI is proportional to the magnitude of the
move.
Wilder believed that tops and bottoms are indicated when RSI goes above 70 or drops below 30. Traditionally, RSI
readings greater than the 70 level are considered to be in overbought territory, and RSI readings lower than the 30
level are considered to be in oversold territory. In between the 30 and 70 level is considered neutral, with the 50 level
a sign of no trend.

Divergence
Wilder further believed that divergence between RSI and price action is a very strong indication that a market
turning point is imminent. Bearish divergence occurs when price makes a new high but the RSI makes a lower high,
thus failing to confirm. Bullish divergence occurs when price makes a new low but RSI makes a higher low.

Overbought and oversold conditions

Wilder thought that "failure swings" above 70 and below 30 on the RSI are strong indications of market reversals.
For example, assume the RSI hits 76, pulls back to 72, then rises to 77. If it falls below 72, Wilder would consider
this a "failure swing" above 70.
Finally, Wilder wrote that chart formations and areas of support and resistance could sometimes be more easily seen
on the RSI chart as opposed to the price chart. The center line for the relative strength index is 50, which is often
seen as both the support and resistance line for the indicator.
If the relative strength index is below 50, it generally means that the stock's losses are greater than the gains. When
the relative strength index is above 50, it generally means that the gains are greater than the losses.
Relative Strength Index 127

Uptrends and downtrends

In addition to Wilder's original theories of RSI interpretation, Andrew Cardwell has developed several new
interpretations of RSI to help determine and confirm trend. First, Cardwell noticed that uptrends generally traded
between RSI 40 and 80, while downtrends usually traded between RSI 60 and 20. Cardwell observed when securities
change from uptrend to downtrend and vice versa, the RSI will undergo a "range shift."
Next, Cardwell noted that bearish
divergence: 1) only occurs in uptrends,
and 2) mostly only leads to a brief
correction instead of a reversal in
trend. Therefore bearish divergence is
a sign confirming an uptrend.
Similarly, bullish divergence is a sign
confirming a downtrend.

Reversals
Finally, Cardwell discovered the
existence of positive and negative
reversals in the RSI. Reversals are the Example of RSI Indicator Divergence

opposite of divergence. For example, a

positive reversal occurs when an uptrend price correction results in a higher low compared to the last price
correction, while RSI results in a lower low compared to the prior correction. A negative reversal happens when a
downtrend rally results in a lower high compared to the last downtrend rally, but RSI makes a higher high compared
to the prior rally.
In other words, despite stronger momentum as seen by the higher high or lower low in the RSI, price could not make
a higher high or lower low. This is evidence the main trend is about to resume. Cardwell noted that positive reversals
only happen in uptrends while negative reversals only occur in downtrends, and therefore their existence confirms
the trend.

Cutler's RSI
A variation called Cutler's RSI is based on a simple moving average of U and D,[2] instead of the exponential
average above. Cutler had found that since Wilder used an exponential moving average to calculate RSI, the value of
Wilder's RSI depended upon where in the data file his calculations started. Cutler termed this Data Length
Dependency. Cutler's RSI is not data length dependent, and returns consistent results regardless of the length of, or
the starting point within a data file.

Cutler's RSI generally comes out slightly different from the normal Wilder RSI, but the two are similar, since SMA
and EMA are also similar.
Relative Strength Index 128

References
[1] J. Welles Wilder, New Concepts in Technical Trading Systems, ISBN 0-89459-027-8
[2] Cutler's RSI page (http:/ / www. aspenres. com/ Documents/ AspenGraphics4. 0/ CutlersRSI. htm) at Aspen Graphics Technical Analysis
Software

External links
• Cardwell Techniques with the RSI (http://www.optionetics.com/market/articles/19819)

Stochastic oscillator
In technical analysis of securities trading, the stochastics oscillator is a momentum indicator that uses support and
resistance levels. Dr. George Lane promoted this indicator in the 1950s. The term stochastic refers to the location of
a current price in relation to its price range over a period of time.[1] This method attempts to predict price turning
points by comparing the closing price of a security to its price range.
The indicator is defined as follows:

where H and L are respectively the highest and the lowest price over the last periods, and

In working with %D it is important to remember that there is only one valid signal—a divergence between %D
and the security with which you are working.[2]

Definition
The calculation above finds the range between an
asset’s high and low price during a given period of
time. The current securities price is then expressed as a
percentage of this range with 0% indicating the bottom
of the range and 100% indicating the upper limits of the
range over the time period covered. The idea behind
this indicator is that prices tend to close near the
extremes of the recent range before turning points. The
Stochastic oscillator is calculated:

Where
is the last closing price Stochastics Fast & Slow

is the lowest
price over the last N periods
is the highest price over the last N periods
is a 3-period exponential moving average of %K.
is a 3-period exponential moving average of %D.
A 3-line Stochastics will give you an anticipatory signal in %K, a signal in the turnaround of %D at or before a
bottom, and a confirmation of the turnaround in %D-Slow.[3] Typical values for N are 5, 9, or 14 periods. Smoothing
the indicator over 3 periods is standard.
Stochastic oscillator 129

Dr. George Lane, a financial analyst, is one of the first to publish on the use of stochastic oscillators to forecast
prices. According to Lane, the Stochastics indicator is to be used with cycles, Elliot Wave Theory and Fibonacci
retracement for timing. In low margin, calendar futures spreads, you might use Wilders parabolic as a trailing stop
after a stochastics entry. A centerpiece of his teaching is the divergence and convergence of trendlines drawn on
stochastics, as diverging/converging to trendlines drawn on price cycles. Stochastics predicts tops and bottoms.

Interpretation
The signal to act is when you have a divergence-convergence, in an extreme area, with a crossover on the right hand
side, of a cycle bottom.[4] As plain crossovers can occur frequently, one typically waits for crossovers occurring
together with an extreme pullback, after a peak or trough in the %D line. If price volatility is high, an exponential
moving average of the %D indicator may be taken, which tends to smooth out rapid fluctuations in price.
Stochastics attempts to predict turning points by comparing the closing price of a security to its price range. Prices
tend to close near the extremes of the recent range just before turning points. In the case of an uptrend, prices tend to
make higher highs, and the settlement price usually tends to be in the upper end of that time period's trading range.
When the momentum starts to slow, the settlement prices will start to retreat from the upper boundaries of the range,
causing the stochastic indicator to turn down at or before the final price high.[5]
An alert or set-up is present when the %D line is in an extreme area and diverging from the price action. The actual
signal takes place when the faster % K line crosses the % D line.[6]
Divergence-convergence is an indication that the momentum in the market is waning and a reversal may be in the
making. The chart below illustrates an example of where a divergence in stochastics relative to price forecasts a
reversal in the price's direction.
Stochastic oscillator 130

Stochastics pop
This is when prices pop through and keep on going - that is, break out.
Rules to follow:
Increase long position — When price crosses the upper band from below.
Increase short position — When price crosses the lower band from above.
Liquidate position — When Stochastic %D crosses %K in direction reversed to open trade.[7]

References
[1] Murphy, John J. (1999). " John Murphy's Ten Laws of Technical Trading (http:/ / stockcharts. com/ school/ doku.
php?id=chart_school:trading_strategies:john_murphy_s_ten_laws)".
[2] Lane, George M.D. (May/June 1984) “Lane’s Stochastics,” second issue of Technical Analysis of Stocks and Commodities magazine. pp
87-90.
[3] Lane, George C. & Caire (1998) "Getting Started With Stochastics" pg 3
[4] Lane, George M.D. (May/June 1984) “Lane’s Stochastics,” second issue of Technical Analysis of Stocks and Commodities magazine. pp
87-90.
[5] Person, John L (2004). A Complete Guide to Technical Trading Tactics: How to Profit Using Pivot Points, Candlesticks & Other Indicators.
Hoboken, NJ: Wiley. pp. 144–145. ISBN 0-471-58455-X.
[6] Murphy, John J (1999). Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications. New
York: New York Institute of Finance. p. 247. ISBN 0-7352-0066-1.
[7] Bernstein, Jake (1995). The Complete Day Trader. New York: McGraw Hill. ISBN 0-07-009251-6.

External links
• Stochastic Oscillator at Investopedia (http://www.investopedia.com/terms/s/stochasticoscillator.asp)
• Stochastic Oscillator page (http://stockcharts.com/school/doku.
php?id=chart_school:technical_indicators:stochastic_oscillator) at StockCharts.com
Williams %R 131

Williams %R
Williams %R, or just %R, is a technical analysis oscillator showing the current closing price in relation to the high
and low of the past N days (for a given N). It was developed by a publisher and promoter of trading materials, Larry
Williams. Its purpose is to tell whether a stock or commodity market is trading near the high or the low, or
somewhere in between, of its recent trading range.

The oscillator is on a negative scale, from -100 (lowest) up to 0 (highest), considered unusual since it is the obverse
of the more common 0 to 100 scale found in many Technical Analysis oscillators. Although sometimes altered (by
simply adding 100), this scale needn't cause any confusion. A value of -100 is the close today at the lowest low of
the past N days, and 0 is a close today at the highest high of the past N days.

Buy-/Sell-Signalling
Williams used a 10 trading day period and considered values below -80 as oversold and above -20 as overbought.
But they were not to be traded directly, instead his rule to buy an oversold was
• %R reaches -100%.
• Five trading days pass since -100% was last reached
• %R rises above -95% or -85%.
or conversely to sell an overbought condition
• %R reaches 0%.
• Five trading days pass since 0% was last reached
• %R falls below -5% or -15%.
The timeframe can be changed for either more sensitive or smoother results. The more sensitive you make it, though,
the more false signals you will get.

Notes
Due to the equivalence

the %R indicator is arithmetically exactly equivalent to the %K stochastic oscillator, mirrored at the 0%-line, when
using the same time interval.
 132

INDICATORS: Volume

Volume (finance)
Volume, or trading volume, is a term in capital markets, referring to the number of shares or contracts traded in a
security or in an entire market during a given period of time.
In the context of stock trading on a stock exchange, the volume is commonly reported as the number of shares that
changed hands during the day. Average volume is reported as the average volume over a longer period of time,
normally one to three months. When the significant positive or negative news is made public about a company, the
volume of the company's stock will usually deviate from its average volume, meaning that more people are trading
this stock.
Higher volume for a stock is an indicator of higher liquidity. For institutional investors who wish to sell a large
number of shares of a certain stock, lower volume will force them to sell the stock slowly over a longer period of
time.

Legal implications
The calculation of the volume of a security has some legal implications. For example, in the United States, a person
who sells a certain number of shares of a security in proportion to its weekly volume may be deemed an underwriter
of that security under Rule 144 of the Securities Act of 1933. The calculation of the trading volume is therefore
regulated by the SEC[1] .

References
[1] SEC Interpretation: Calculation of Average Weekly Trading Volume under Rule 144 and Termination of a Rule 10b5-1 Trading Plan (http:/ /
www. sec. gov/ rules/ interp/ 33-8005a. htm)