Taken From: Technical Analysis of the Financial Markets A Comprehensive Guide to Trading Methods & Applications John Murphy, New York Institute of Finance, Published 1999
Technical Indicators Technical 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
Types of indicators Market Strength Advance Decline Line Open Interest VIX Momentum Moving averages MACD Parabolic SAR Rate of change Oscillators Stochastics RSI Volume OBV
General rules to indicators 1. 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 Indicators To 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 Line Best 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 example http://stibreadth.blogspot.com/ Divergence Trend following
VIX - CBOE Volatility Index Constructed using the implied volatilities of a wide range of 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
11
Sources for market strength indicators AD Line Singapore: stibreadth.blogspot.com NYSE: Wall Street Journal, Investor s business daily VIX S&P 500: Yahoo finance ticker ^VIX
Average Directional Index ADX Gauge of strength of prevailing trend Does not determine the direction of trend Ranges from 0 to 100, but rarely above 60
Using ADX ADX < 20 ADX > 30 ADX > 40 Weak trend Confirm with low volumes Indicates strong trend Trend likely to weaken imminently Action Price basing action, draw support or resistances Enter on breakout of trendline, MA or price pattern Watch for ADX to form a top and retrace to the MA
ADX example KS Energy
Momentum Indicators As 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 Change Rate of change = Previous close / Close x days ago Zero as an important level Construction of formula may vary
Using Rate of Change Entering the market 1. Confirm trending 2. Enter in direction of trend when ROC crosses zero Exit after rapid increase or decrease in ROC Exiting the market or When ROC crosses zero
ROC example DBS
ROC example Singtel 21
Moving Average Convergence Divergence - 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 MACD Confirmation of reversal 1. MACD cutting its signal line Reversal of momentum 2. MACD cutting the zero line Reversal of trend Spotting divergence or confirming convergence 1. MACD cutting its signal line Reversal of momentum 2. MACD cutting the zero line Reversal of trend
MACD example Cosco
MACD example STI Monday, 7 Jan 2008
MACD example China Aviation Oil
Oscillators Extremely 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 example Chartered Semicon
RSI example Chartered Semicon
RSI example 32
Practice Time Capitaland Daily 2006 MACD Raffles Education Daily 2007 RSI & ADX 33