Technical Analysis
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Introduction
Technical analysis is the rigorous analysis of past market data, usually using charts, to forecast future market movement.
Technical analysis is based on the following three assumptions:
1. The market takes all relevant information into account
Everything that influences the market price of a stock or currency exerts either upward or downward pressure on the price. The market price then is the point at which these pressures meet.
Price and factors influencing it.2. Prices move in trends
This means that prices move in a particular direction over the course of time. Prices will move in the same direction until something happens to change the trend. Generally speaking, there are three types of trend:
Uptrend (bullish). Price moves upwards.
Downtrend (bearish) Price moves downwards.
Sideways or flat. Price fluctuates up and down with no distinct trend forming.3. Related to the idea that prices move in trends, technical analysis assumes that history tends to repeat itself
Because markets are driven by humans whose reactions to certain events and circumstances are, as history has demonstrated, predicatable, market movement today due to a certain circumstance is likely to mirror movement in the past in the face of a similar circumstance. Many chart patterns are based on the idea that history will repeat itself. - Read Close 2
Dow Theory
Dow Theory is a form of technical analysis derived from the work of American journalist and founder of the Wall Street Journal Charles Dow and articulated by William Hamilton and Robert Rhea.
The basic tenets of Dow Theory:
- 1. Indices discount all available information as soon as the information becomes available.
- 2. There are three types of movements: primary movements, secondary movements and daily fluctuations (short swing). The primary movement may last anywhere from a few months to a few years and represents the primary trend of the market. The secondary movement lasts from a few weeks to a few months and represents a reaction against the primary trend. Daily fluctuations can move in any direction but generally only last from a few hours up to a week.
- 3. There are three phases of the primary trend: accumulation phase, public participation phase, distribution phase. During accumulation stage, informed investors begin buying even as the market at large is at a low point. The accumulation phase generally begins at the end of a downturn and is often mistaken for a correction. Eventually the market catches on to what the early investors saw and a rapid rise in price ensues. This ushers in the public participation phase where trend followers jump onboard and the price enters a sustained climb. The third stage is marked by rampant speculation. At this point the "smart money" begins to get out, finding willing buyers among the speculators. The ideas are the same for the beginning of a bear market, only reversed.
- 4. Indices must confirm each other. The idea is that various sectors of the economy depend on each other should experience the same ups and downs. If manufacturing slows down, railroads and shipping should slow down as well. A diversion in performance is often seen to signal changing economic conditions.
- 5. Trends are confirmed by volume. Price movement during times of low volume trading carries less weight than movement during periods of high trading. Dow believed that market movement accompanied by high volume represented the "true" market view.
- 6. Trends continue until definitive signals to the contrary appear. Markets may fluctuate over the short term and even show movement against the trend, but in the abscence of clear signals to the contrary, the trend will resume. Determining where a reversal is temporary or the beginning of a new trend is one of the most difficult things a trader faces.
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Trend Analysis.
There are three types of trend.
- 1. Uptrend (bullish) where prices are rising.
- 2. Downtrend (or bearish) where prices are falling.
- 3. Flat or Range where prices are neither rising nor falling.
Within a trend, there may be temporary movement with the trend (impulsive movement) or against the trend (corrective movement).
Support/Resistance Levels
Support and resistance levels are points on a graph where supply meet demand. As the price moves up and down through time, the support and resistance levels can be thought of as containing the price. In other words it is the point that is believed to be where the price will stop and reverse. during a
Resistance: lines are drawn connecting the peaks of the chart. This indicates the price at which sellers outnumber buyers, thus driving the price back down. Traders watch resistance points very carefully. Once the price breaks through the resistance level, it usually keeps rising until finding a new resistance point.
Support: are lines drawn connecting low points on the chart.
These are points at which the price finds buyers, thus bringing the price back up. As with resistance points, if the price breaks through the support points, it often continues to go down until new support points are found.
Channel Lines
Channel lines are drawn parallel to the main trendline and indicate points at which the price begins to diverge from the current trend line. If the price does not reach the trend line, it could be a sign that the current trend is losing momentum.
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Chart Patterns
The key to using charts is to recognize patterns. Given that the basis of technical analysis is that price movement (and therefore its reflection on charts) repeats itself and is therefore predictable with proper analysis. Chart patterns are tools used to predict trend reversal or trend continuation.
Head and Shoulders
Head and shoulders is a well-known reversal pattern - meaning that the currency is likely to move against the previous trend (for the Head and Shoulders to apply, there must be an established trend, otherwise the pattern doesn't apply here). As the name suggests, the pattern resembles a head and two shoulders. There is a third element called a "neckline" which is drawn by connecting the low of the left shoulder (which is also the beginning of the head), and the end of the head (also marking the beginning of the right shoulder). There are two versions of the head and shoulders pattern- a "top" (showing a currency's price is about to fall) and "bottom" (anticipating a rise in price). Below we see a "top" pattern indicating a likely fall in the price.
Below we see the opposite type of pattern, a "botton". When the price breaks through the neckline, it will be expected to rise, thus marking the beginning of a new trend.
Volume is used to confirm the pattern. Theoretically, volume should be higher where the left shoulder is ascending than during the ascension of the head. Final confirmation comes when volume rises higher still during the decline of the right shoulder.
Triple and Double Tops and Bottoms
Double Tops and Bottoms, like Head and Shoulders, is a reversal pattern. The pattern consists of two roughly equal peaks with a moderate trough in between. Reduced volume on the second peak following by increased volume on the decline is considered to be a confirmation. Double Tops are considered difficult to trade because of their similarity to Triple Stops, a much rarer but nevertheless often confusing pattern for traders. Below is shown a Double Botton. Note the rise in price following the second trough. This is in line with the same principle mentioned above with the Double Top.
V-Reversal Pattern (Spike)
Spike V's are sharp and definite direction reversals creating a pattern on the chart as shown below. V-Tops are more common than V-bottoms for the simple reason that once everyone is invested, there's nowhere to go but down, whereas when an asset is at the botton, it usually takes time for it to build momentum. While predicting spikes are very difficult, traders should know how to react when they do occur.
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Triangle
Triangle (Chart Pattern)
A "triangle" is a pattern showing an increasingly narrow price range on a chart. There there are three types of triangle: ascending, decending and symmetrical. The most important aspect of analysis with triangles is not necessary the shape of the triangle itself, but where the market goes when when it breaks out of the triangle.
The image above shows an ascending triangle. The highs increase gradually while the lows stay roughly the same indicating increasing buying pressure. In an uptrend, an ascending triangle is seen as a confirmation of the trend. In a downtrend, a ascending triangle can be a powerful signal of a reversal.
Here we see a descending triangle. Using the same logic as with the increasing triangle, a descending triangle in a downtrend is a continuation of the trend but in an uptrend it may signal a reversal.
A symmetrical triangle is one in which the highs are higher and the lows are lower and is common in directionless markets. The key here is which direction the market breaks to out of this pattern.
Flags
The Flag formation is a short term continuation pattern that marks a consolidation and is marked by sharp movement in either direction on heavy volume.
Pennants
Penants are brief periods of sideways motion after a sharp increase or decrease. Penants resemble symmetrical triangles and are considered to be a continuation pattern.
Wedge
The wedge pattern is a common chart pattern showing a contracting range of prices. The prices may be moving upwards or downward with the wedge being called an upward or downward wedge accordingly.
Rectangles
The rectangle is a pattern in which the price oscillates consistently within the resistance and support lines without breaking through on either side. A breakthrough on either side is considered a good entry point.
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Trend Indicators.
Moving Average.
The moving average indicator takes the average price over a period of time. Because price fluctuations can often obscure the true movement of a currency, moving averages are used to smooth out the chart data.
Simple Moving Average — SMA:
The simple moving average is the most basic moving averages using in trading. The SMA tracks the price of a currency over a certain period of time by dividing the average closing price by the number of time frames.
Weighted Moving Average (WMA):
Is a moving average in which more weight is given to more recent data. Each daily average is given a weight before being plugged into the formula which produces the average.
Exponential Moving Average (EMA):
An Exponential Moving Average is similar to a Weighted Moving Average except that more weight is given to recent data which allows it to react faster to changes in the market. The significance of each day's data increases exponentially thus
How to analyze Moving Averages:
Moving averages can be very effective in determining the trend of a currency through the noise of market fluctuations. There are a few technical signals to be aware of.
If the price crosses the Moving Average line from below, then this is a signal to buy. By the same token, when the price crosses from above, it may be time to sell.
The moving average line can, however give false signals especially in a fast moving market. Often, cross-points of two Moving Average indicators of different periods are used (n1 and n2);
It the Moving Average uses a longer time period, it may be able to to determine the trend though it will be less sensitive to price movements;
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Alligator
Currency trading expert Bill Williams created this hybrid indicator as part of his Chaos Theory. The alligator consists of three parts:
Alligator's Jaw (the blue line) — 13-period moving average at the mid price (High+Low)/2, which is offset 8 bars into the future;
Alligator's Teeth (the red line) — 8-period moving average at the mid price (High+Low)/2, which is offset 5 bars into the future;
Alligator's Lips (the green line) — 5-period moving average at the mid price (High+Low)/2, which is offset 2 bars into the future.
If all three lines are intertwined, the market is "asleep" and not likely to move sharply in any direction. According to Alligator theory, the longer the market sleeps, the more tension builds (many explanations use the analogy with an actual alligator, i.e. the longer is sleeps, the hungrier it gets). When the market does "awaken", the movements will be sharper.
If the market is not asleep, it's either in an uptrend or a downtrend. The trend can be determined as follows:
- 1. if the price is above the Alligator's mouth then it's an uptrend;
- 2. if the price is below the Alligator's mouth then it's a downtrend.
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Ichimoku Kinko Hyo
The Ichimoku Kinko Hyo (for short, Ichimoku) is a technical analysis indicator developed in the 1930s by Japanese journalist Hosoda. The word "Ichimoku" means "one look" which reflects Hosoda's desire to find one indicator which measures several aspects of the market at once. The indicator measures trend and momentum and also support and resistance lines. Ichimoku is more effective on longer time frames.
Ichimoku consists of five lines:
- Tenkan-sen — the average price level, (High+Low)/2, calculated over the first time period;
- Kijun-sen — the average price level over the second time period;
- Senkou Span A / Up Kumo — midway between Tenkan-sen and Kijun-sen, shifted forward for the length equal to the second time period;
- Senkou Span В / Down Kumo — the average price level over the third time period, shifted forward for the length equal to the second time period;
- Chinkou Span — current bar close, shifted backward for the length equal to the second time period.
Senkou Span A and Senkou Span B form a "cloud" known as the "Kumo", which changes its color when these lines cross.
If the price stays above the cloud then there is an upward trend. If it stays below the cloud then there is a downward trend. If the price is within the cloud then the market is flat. If Tenkan-sen line moves sideways then it is a signal for a flat market.Ichimoku Kinko Hyo indicator signals:
When the price exits the cloud downward, it is a sell signal, upward – buy signal. The price ranges before and after the cloud are often the same.
When the price and Chinkou Span (green line) intersect it is a signal to make a trade. If Chinkou Span crosses the price line from below it is a buy signal, if it crosses from above it is a sell signal
If Tenkan-sen (red line) crosses Kijun-sen (blue line) from above it is a sell signal, and vice versa
When the price is inside the cloud it tends to move in the direction of Tenkan-sen line (red line). If the Tenkan-sen line is directed downwards then the price tends to move to the lower edge of the cloud and vice versa
Kijun-sen (blue line) and cloud edges are very strong resistance/support levels.
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Elder Ray Indicator
The Elder-ray indicator (named after its founder Alexander Elder) is a mechanical trading system which measures the relative strength of buying pressure vs selling pressure over a certain period of time. The Elder-ray indicator consists of two parts known as the "Bear Power" and "Bull Power."
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The Elder Ray calculation is based on
- The idea that the market price is a compromise between sellers and buyers;
- The Moving Average is the average compromise over a period of time;
- The highest price in a time period is the maximum expression of the "bullish force". The lowest price is the opposite.
The Elder Ray consists of three horizontal charts:
- 1. A chart with a 13-period exponential moving average. A rise in the moving average signals a bullish trend and a fall shows a bearish trend.
- 2. A chart with a histogram of the Bullish Force.
- 3. A chart with a histogram of the Bearish Force.
The Bullish / Bearish Force is calculated as follows:
Bulls Power = High — EMA,
Bears Power = Low — EMA,
where:
High — the maximum price over the period;
Low — the minimum price over the period;
EMA — exponential moving average.
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Envelopes (Price Channel)
Envelopes are two parallel lines plotted above and below the moving average which are thought to show the band in which a currency is trading. One envelope is plotted above the moving average and one below. The envelopes can be plotted at various distances from the moving average depending on the strategies of the trader. It is, however, standard practice to set the envelopes so that about 95% of price activity is contained within the envelopes.
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Bollinger Bands
Bollinger Bands are a technical analysis tool invented in the late 1980s by investment expert John Bollinger. They are used mainly to evaluate price volatility. Bollinger bands consist of three bands plotted on the chart of any currency. The middle band is simply a moving average and serves as a base for the upper and lower lines. The upper band is plotted K times an N-period standard deviation above the middle band with the lower band plotted K times an N-period standard deviation below the middle band.
How to trade Bollinger Bands:
- 1. The lower band often indicates buy support and the upper band may show sell resistance;
- 2. If the price leaves the band on either side, it will almost always return shortly thereafter;
- 4. Bollinger Bands widen when the prevailing trend becomes stronger or at the beginning of a new trend. A good trend confirmation is when bands widen and volume rises. In a bullish market, the moving average is the support level, whereas in a bearish market it is the resistance level.
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Moving Average Convergence Divergence (MACD)
The MACD is a technical indicator used to identify changes in the strength, direction or momentum of a trend. It is a computation of the difference between two exponential moving averages. The MACD indicator is often plotted separately below the main graph of a currency and shows the MACD line (the difference between the 12-day EMO and the 26-day EMO) and the signal line which is the 9-day moving average of the MACD itself. Traders look for points where the moving averages converge, diverge or even crossover.
Interpretation
- When the MACD line crosses up through the signal line (signal line crossover) it's seen as a signal to buy.
- By the same token, when the MACD line crosses below the signal line, it's a signal to sell.
- Another clue may be divergence between the MACD line and the graph of the currency price. A downward trend may be coming to an end when the price hits a new low but the MACD does not. Reverse the idea for the end of a bullish trend.
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Average True Range (ATR)
Average True Range (ATR) is an indicator which shows market volatility. The ATR does not indicate the trend of the price, merely the degree of volatility. The ATR is based on the range of trading within a day (called the "true range value" which is merely the day's low substracted from the high. The true range value also extends to the closing price of the prior day if it falls outside the day's range.
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Parabolic SAR
The Parabolic SAR is used primarily to determine entry and exit points in the market. Many traders use the indicator as a trailing stop for open positions.
When a currency's price is above the indicator, it is better to be long in the currency and by the same token, the currency is trading below the indicator, it is good to be short.
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Average Directional Movement Index (ADX)
Average Directional Movement Index (ADX) shows
The ADX is an indicator showing the existence and strength (though not the direction) of a trend and is plotted along with two lines called Directional Movement Indicators. The ADX is derived from the relationship of the two lines. Traders use this indicator to determine the strength of a trend as well as when to let profits continue to run.
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Relative Strength Index (RSI)
The RSI is classified as a momentum oscillator which measures the rate of change of price movements.
RSI = 100 — (100 / (1 + U / D))
where
U — average value of the positive price changes over a period;
D — average value of the negative price changes over a period.Relative Strength Index (RSI) signals:
- If the indicator is below the 50 line, then the market is considered to be bearish, if above the 50 level - bullish;
- Bullish divergence / bearish convergence – the main signal of the trend weakness and possible reverse;
- Under flat conditions exit from the overbought (oversold) area is a signal to sell (buy);
- Moreover, different types of the trend analysis can be used to analyze Relative Strength Index (RSI): trend lines, support / resistance levels, chart reversal and continuation patterns.
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Relative Vigor Index (RVI)
Relative Vigor Index (RVI) calculation is based on the idea that in a rising market the closing price is usually higher than the opening price, and on the bearish market the closing is usually below the opening price.
To normalize the index the price fluctuation is divided by the maximum price range within the bar:
RVI = (CLOSE — OPEN) / (HIGH — LOW)
Where:
OPEN — open price;
HIGH — the highest price;
LOW — the lowest price;
CLOSE — close price.ДTo eliminate occasional price fluctuations (so called "noise") the Relative Vigor Index (RVI) oscillator is smoothed by the 10-period simple moving average. A signal line is also formed as a 4-period moving average on the oscillator values.
The basic signals of Relative Vigor Index (RVI) are:
- Bullish divergence / bearish convergence ? the main signal pointing to the weakness of the current trend;
- A good moment to open a sell / buy position is the crossing of the RVI line by the signal line from above/below once the bullish divergence / bearish convergence has appeared on the chart;
- In a flat market an exit from the overbought / oversold area is a signal to sell / buy.
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Williams’ Percent Range (R)
The formula to calculate Williams’ Percent Range oscillator is similar to the one used to calculate the Stochastic Oscillator:
%R = (MAX (HIGH (i — n)) — CLOSE (i)) / (MAX (HIGH (i — n)) — MN (LOW (i — n))) * 100
Where:
CLOSE (i) — the current close price;
MAX (HIGH (i — n)) — the highest top over the previous n periods;
MIN (LOW (i — п)) — the lowest bottom over the previous n periods.The values of the Williams’ Percent Range (%R) oscillator lie between 0 and -100%. If the oscillator is between -80% to -100%, it indicates an oversold condition, whereas values in the range from 0% to -20% signify an overbought condition.
Signals:
- bullish divergence / bearish convergence — the main signals that point to the weakness of the current trend;
- in a flat market an exit from the overbought / oversold area is a signal to sell / buy.
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Standard Deviation (SD)
A measure of the market volatility. This indicator characterises prices fluctuation against MA. If the value of the indicator is high the market is volatile and bars prices are different against MA. If the value of the indicator is not high the market is characterized by a low volatility and bars prices are quite near MA.
Usually this indicator is used as a component of other indicators. Thus, when Bollinger Bands are calculated the value of the standard deviation of the instrument is added to its MA.
Calculation
StdDev (i) = SQRT (AMOUNT (j = i — N, i) / N)
AMOUNT (j = i — N, i) = SUM ((ApPRICE (j) — MA (ApPRICE (i), N, i)) ^ 2)
where:
StdDev (i) &— Standard Deviation of th current bar;
SQRT — square root;
AMOUNT(j = i — N, i) — sum of roots from j = i — N to i;
N — smoothing period;
ApPRICE (j) — applied price of j-bar;
MA (ApPRICE (i), N, i) — any MA of the current bar for N periods;
ApPRICE (i) — applied price of the current bar.The market dynamics consists of successive alternation of periods of rest and moments of active trading, that is why approach to this indicator is simple:
- if the value of the indicator is too low, that is the market is calm, a moment of active trading should be expected soon;
- on the contrary, if the indicator is too high it means that activity may decrease soon.
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Commodity Channel Index (CCI)
Commodity Channel Index (CCI) calculations.
1) Find a typical price: add high, low and close of each bar and divide it by 3
TP = (High + Low + Close) / 32) Subtract SMA of the typical prices over n-periods, SMA (TP, N), from the typical prices (TP)
D = TP — SMA(TP, n)3) Multiply SMA (D, N) by 0,015
M = SMA (D. n) * 0,0154) The final value of the indicator
CCI = M / DThe main signals for CCI:
- Bullish divergence / bearish convergence is not always a signal of the weakness of the trend, but always quite accurately defines the beginning of the correction;
- Under flat conditions exit from the overbought / oversold areais a sell (buy) signal.
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Moving Average of Oscillator (OsMA)
Moving Average of Oscillator (OsMA) is generally calculated as the difference between the oscillator and the moving average on the oscillator. In MetaTrader 4, MACD is used as an oscillator, and a SIGNAL (signal line) is used as a moving average:
OSMA = MACD-SIGNAL
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Stochastic Oscillator
The aim of the Stochastic Oscillator is to determine price behaviour and reversals by monitoring close prices within the recent highs and lows.
The method is based on the observation that when prices are rising their close levels tend to be closer to the top. If the prices keep rising whereas daily close levels start falling it signals that the trend is ready for the reversal.
If the quotes tend to move downwards, the close is usually near the bottom.СThere are three stochastic lines: %K, %D, %R. They reflect current close price position against the chosen time period.
%K = 100 ( ( C — Ln ) / (Hn — Ln) )
where
C — current close price,
Ln — the lowest bottom within the number of bars of the chart
Hn — the highest top within the number of bars.
%D = SMA (%D , n1)
n1 — the value of the simple moving average.The main signals for Stochastic:
- The indicator was created in order to trade in the flat market. Now bullish divergence / bearish convergence is the main signal that shows that the current trend is weak and reversal or correction are possible;
- In a flat market, exit from the overbought (oversold) area is a signal to sell (to buy);
- If the solid line (%K) crosses the dashed line (%D) from below this is a signal to buy; if the solid line (%K) crosses the dashed line (%D) from above this is a signal to sell.
Interaction between oscillators and price chart (hereinafter price is above and oscillator is below)
Bearish convergence:
middle signal
If the end of the oscillator is near the upper edge price fall is possible.
If the end of the oscillator is near the upper edge price fall is possible.
weak signal
We expect price stabilization with further trend change.
middle signal
If the end of the oscillator is near the upper edge trend strengthening is possible.
If the end of the oscillator is near the lower edge price rise is more possible.
If the end of the oscillator is near the mid price fall and stabilization are equally possible.
Bullish divergence:
middle signal
If the end of the oscillator is near the lower edge price rise is possible.
If the end of the oscillator is near the mid price fall is more possible.
weak signal
We expect price stabilization with further trend change
middle signal
If the end of the oscillator is near the lower edge trend strengthening is possible.
If the end of the oscillator is near the upper edge price stabilization is possible.
If the end of the oscillator is near the mid price rise and stabilization are equally possible.
Parallelism:
middle signal
Strong trend upwards
weak signal
Trend change is expected
middle signal
Strong trend downwards
Final note
When the trend is strong oscillators should be treated carefully. As a rule, false signals indicate the trend strengthening.
If the trend is upward oscillators are mainly in the overbought area and vice versa if the trend is downward oscillators are mainly in the oversold area.
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Volume Indicators
The main principles of using volume indicators:
- When volume decreases it means that there is less interest, so it may be time for a reversal or price consolidation.
- When volume increases it means that there is more interest, so it may strengthen the prevailing trend or a new trend may appear.
- Sometimes gradual decreasing in volume is accompanied by rapid price movements.
- Volume highs signal that it may be time for a reversal.
On Balance Volume — OBV
1) If the current close price is above the preceding one, that is C( i ) > C(i — 1), then: OBV(i) = OBV(i-1) + Volume (i)
2) If the current close price is below the preceding one, that is C( i ) < C(i - 1), then: OBV(i) = OBV(i-1) - Volume (i)
wnere
C( i ) - current Close;
C(i - 1) - Close of the previous bar;
Volume (i) - current bar volume.
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Accumulation / Distribution Indicator
A/D = SUM (((Close — Low)-(High — Close)) * Volume / (High — Low) , N )
Accumulation / Distribution (A/D) indicator is similar in most aspects to the On Balance Volume (OBV) indicator but it is more complex.
Accumulation / Distribution indicator signals:
- if a new price high is confirmed by a new Accumulation / Distribution (A/D) indicator high this means that the bullish trend is strong;
- if a new price bottom is confirmed by a new Accumulation / Distribution (A/D) bottom this means that the bearish trend is strong;
- bullish divergence warns of the weakness of the uptrend;
- bearish convergence warns of the weakness of the downtrend;
- breakout of the trend line drawn on Accumulation / Distribution (A/D) indicator warns of the high possibility of the breakout of the trend line on the price chart.
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Force Index
RFI = Volume * (Close — Close(-1))
FI = MA (RFI , n)where
Volume — current volume value;
Close — the close price of the last bar;
Close(-1) — the close price of the previous bar;
MA — moving average.
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Money Flow Index – MFI
It is calculated as follows:
1) Define a "Typical Price" (TP) for the specified period:
TP = (High + Low + Close) / 32) Calculate "Money Flow" value (MF):
MF = TP * Volume
If "Typical Price" is higher than the preceding one then "Money Flow" is positive. If "Typical Price" is lower than the preceding one then "Money Flow" is negative.3) Calculate "Positive Money Flow" and "Negative Money Flow":
MR = PMF / PMF4)."Money Ratio" (MR) is calculated as follows:
MFI = 100 — (100 / (1 + MR)
Where
С — current bar close price;
С (-1) — Close of the previous bar;
Volume — current bar volume.
Money Flow Index (MFI) signals:
- if a new price high is confirmed by a new indicator high it means that the bullish trend is strong;
- if a new price bottom is confirmed by indicator bottom is means that the bearish trend is strong;
- bullish divergence warns of the weakness of the uptrend. Bearish convergence warns of the weakness of the downtrend.
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Market Facilitation Index (BW MFI)
Market Facilitation Index (BW MFI) is calculated as follows:
BW MFI = (HIGH — LOW) / VOLUME
Where:
HHIGH — the highest price of the current bar; LOW — the lowest price of the current bar; VOLUME — volume of the current bar.Signals:
- When both BW MFI and Volume rise at the same time, it means that the market is moving primarily in one direction and that more people are participating in the market (volume increases). It is a good time to be already in the market.
- When both BW MFI and Volume decrease at the same time, it means that traders' interest starts to fade. Often it occurs toward the end of the trend.
- When BW MFI is pointing higher and Volume is pointing lower, it means that the market primarily moves in one direction but there are no new participants to generate higher volume. Price movements are the result of speculation.
- When both BW MFI goes down and Volume goes up, it means that there is a battle between bulls and bears (large volume) and their forces are almost equal (the price does not change significantly). This typically occurs prior to a significant move in the opposite direction. Close attention should be paid to the direction that the price moves when breaking out of this slowdown. Bill Williams called this a squat bar.
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Mechanical Trading Systems
Alexander Elder's Triple Screen Trading System is a vivid example of mechanical trading systems.
Alexander Elder's Triple Screen Trading System
The idea of the Triple Screen Trading System is based on the concept that the market is moving in waves just like waves in the ocean. Every powerful wave consists of smaller ones, which consist of even smaller waves. To trade successfully a trader should choose the moment when waves are moving in the same direction to enter the market.
First Screen - Market Tide
It identifies the long-term trend (e.g. on the weekly chart). The main trend is identified on the basis of the weekly chart and MACD histogram. When histogram is down it is better to open short positions. The selling signal will be stronger when the histogram is below zero. When the histogram is up the best decision is to enter into a long position. Long position opening will be more effective in case the histogram is above zero. The tendency on the first screen is like a tide. And it is better not to swim against the tide.
Second Screen – Market Wave
It identifies the mid-term trend (e.g. on the daily chart). The mid-term trend is indicated with the help of oscillators, such as stochastic, RSI and other indicators created on the daily chart. If the first screen points at the bullish market and oscillators are in the oversold area this is a good signal to buy. And vice versa on the weekly bearish trend when the oscillators are overbought on the daily chart there is a good chance to sell. Waves are signals of the second screen. The Triple Screen Trading System considers only the waves which do not contradict the tide.
Third Screen
It identifies short-term trend, fixing breakouts of highs and lows of the previous day. If price reaches a new high comparing with the previous day, weekly trend increases and daily oscillators fall to the oversold area buy signal forms. If price reaches a new low comparing with the previous day, weekly trend is falling and daily oscillators rise to the overbought area it is high time to sell. The third screen identifies the ripple of the market.
Elder Ray Indicator
Elder Ray Indicator is an additional instrument of the Triple Screen Trading System. Its aim is to measure bullish and bearish force at every moment of time.
The calculation is based on the following principles:
- Price is an agreement between sellers, buyers and square traders;
- The Moving Average is the averaged price agreement;
- The highest price is the maximum of the bullish force over a specified period of time;
- The lowest price is the maximum of the bearish force over a specified period of time.
Elder Ray consists of three horizontal screens:
- 1. The first chart is a chart with a 13-period exponential moving average. When the moving average rises there is a bullish trend. When the moving average falls there is a bearish trend.
- 2.The second chart is a chart with a histogram of the Bullish Force. Bullish Force is calculated as follows:
Bulls Power = High — EMA, where:
High — the maximum price over the period;
EMA — exponential moving average.
If the price top is higher than the moving average, then the Bullish Force is above zero, so the bullish trend is confirmed. Otherwise, bulls are weak. - 3. The third chart is a chart with a histogram of the Bearish Force:
Rears Power = Low — EMA, where Low — the minimum price over the period.
If the price low is below the moving average this means that the downtrend is very strong. Otherwise, bears are weak.
Elder Ray Main Signals
- Buy Signals. Moving average rises and Bullish Force indicator is below zero. The best time to buy is when the Bearish Force first falls below zero and then immediately rises. If new price highs are confirmed by new Bullish Force indicator highs, then it is a good confirmation of the bullish trend. Bearish convergence is another strong signal.
- Sell Signals. Moving average moves downward and Bullish Force is above zero. Bearish trend is confirmed if the price lows and Bearish Force indicator lows move downward in parallel. Bullish divergence is another strong signal.
- Read Close 29
Main Types of Charts
Quite unusual charts are used to show price movement.
1. Bar Charts
This is the most common type of charts. It consists of vertical bars which show the range of the price change within some definite period of time.
For example, on the 1 hour price chart each bar corresponds to the price change range within 1 hour.
In this Picture 1 hour price movement is given.
Then this movement will be shown in the shape of such a bar
- Open — opening price, in this case 1 hour opening price. That is the first price of an hour.
- Close — closing price, in this case 1 hour closing price. That is the last price of an hour.
- Higf — the highest price within this period of time.
- Low — the lowest price within this period of time.
Chart for several hours looks like this
2. Candlesticks or Candles.
This is also a very popular type of charts. It is built just like a bar chart. The distance between the opening and closing prices is given in the shape of the triangle.
If Close is higher than Open the body of the candle is colored in light (in white color).
If Close is lower than Open the body of the candle is dark.
Candlesticks
Japanese Candles Chart
3. Line chart
The line is drawn through the closing prices
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