9

9. ROC – Rate of Change

Rate of Change is an oscillator that measures how fast the momentum of the market is changing over the Observation Period. Rate of Change is very similar to Momentum in that it compares the current price with the price a specified number of periods ago; however Rate of Change is calculated differently. Where Momentum subtracts the current price from the price a specified number of periods ago, Rate of Change divides the current price by the price a specified number of periods ago and then multiplies the result by

The most common uses of Rate of Change are to:

- Indicate overbought and oversold conditions

An overbought or oversold market is one where the prices have risen or fallen too far and are therefore likely to retrace. If the Rate of Change line moves to a very high value above the 100 line, this is a sign of an overbought market. If the Rate of Change line moves to a very low value below the 100 line, this is a sign of an oversold market. Overbought and oversold signals are most reliable in a non-trending market where prices are making a series of equal highs and lows. If the market is trending, then signals in the direction of the trend are likely to be more reliable. For example if prices are in an up trend, a safer trade entry may be obtained by waiting for prices to pullback giving an oversold signal and then turn up again.

- Indicate Bullish and Bearish Divergence

Divergence between the Rate of Change line and the price indicates that an up or down move is weakening. Bearish Divergence occurs when prices are making higher highs but the Rate of Change is making lower highs. This is a sign that the up move is weakening. Bullish Divergence occurs when prices are making lower lows but the Rate of Change is making higher lows. This is a sign that the down move is weakening. It is important to note that although Divergences indicate a weakening trend they do not in them selvesindicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trend line break.

Parameters

Observation Period: (default 14)

Normally the Observation Period is set to half the cycle length of the underlying instrument. Thismeans that the Rate of Change line will peak and bottom along with prices. Using a shorter Observation Period increases the responsiveness of the Rate of Change oscillator while also increasing the risk of false signals. Using a longer Observation Period slows the responsiveness of the oscillator to price changes, resulting in late signals.

10. RSI – Relative Strength Index

Developed by J. Welles Wilder and introduced in his book New Concepts in Technical Trading Systems. RSI calculates the difference in values between the closes over the Observation Period. These values are averaged, with an up average being calculated for periods with higher closes and a down-average being calculated for periods with lower closes. The up average is divided by the down average to create the Relative Strength. Finally, the Relative Strength is put into the Relative Strength Index formula to produce an oscillator that fluctuates between 0 and 100. By calculating the RSI in this way Wilder was able to overcome two problems he had encountered with other momentum oscillators. Firstly, the RSI should avoid some of the erratic movements common to other momentum oscillators by smoothing the points used to calculate the oscillator. Secondly, the Y Axis scale for all instruments should be the same, 0 to 100. This would enable comparison between instruments and for objective levels to be used for overbought and oversold readings.

The most common uses of RSI are to:

- Indicate overbought and oversold conditions

An overbought or oversold market is one where prices have risen or fallen too far and are therefore likely to retrace. If the RSI is above 70 then the market is considered to be overbought, and an RSI value below 30 indicates that the market is oversold. 80 and 20 can also be used to indicate overbought and oversold levels. Overbought and oversold signals are most reliable in a non-trending market where prices are making a series of equal highs and lows. If the market is trending, then signals in the direction of the trend are likely to be more reliable. For example if prices are in an up trend, a safer trade entry may be obtained by waiting for prices to pullback giving an oversold signal and then turn up again.

- Generate buy and sell signals

If the RSI is above 70 and you are looking for the market to form a top, then the RSI crossing back below 70 can be used as a sell signal. The same is true for market bottoms, buying after the RSI has moved back above 30. These signals are best used in non-trending markets. In trending markets, the most reliable signals will be in the direction of the trend. For example if the market is trending up, taking only buy signals after the RSI has moved back above 30 after dipping below it. The reason for taking signals only in the direction of the trend, is that when the market is trending any countertrend signal is likely to indicate a small retracement against the underlying trend rather than true reversal.

- Indicate Bullish and Bearish Divergence

Divergence between the RSI and the price indicates that an up or down move is weakening. Bearish Divergence occurs when prices are making higher highs but the RSI is making lower highs. This is a sign that the up move is weakening. Bullish Divergence occurs when prices are making lower lows but the RSI is making higher lows. This is a sign that the down move is weakening. It is important to note that although Divergences indicate a weakening trend they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trend line break.

Parameters

Observation Period: (default 14)

Lower Bound percentage (default 30); this provides the lower boundary expressed as a percentage of the instrument's value. The number must be less than the Upper Bound. Upper Bound percentage (default 70); this provides the upper boundary expressed as a percentage of the instrument's value. Wilder used 14 as an Observation Period although periods of 9 and 7 are also popular. Decreasing the observation period increases the sensitivity of the RSI to changes in price, resulting in a more responsive RSI.

Note that a shorter observation period may also result in an increase in the number of false signals. A longer period results in a smoother RSI that will generate less signals.

11. Slow Stochastic

Stochastics are an oscillator developed by George Lane and are based on the following observation: As prices increase - closing prices tend to be closer to the upper end of the price range As prices decrease - closing prices tend to be closer to the lower end of the price range Slow Stochastics are based on Fast Stochastics but provide a slower, smoother response to price movements.

Slow Stochastic consist of two lines, %K and %D:

The %K line in Slow Stochastic is the same as the %D line in Fast Stochastic. The %D line in Slow Stochastic is a Simple Moving Average of %K Slow Stochastic. This line is smoother than the %K and provides the signals for an overbought / oversold market. Slow Stochastics are the more commonly used of the two Stochastic types - Fast and Slow. This is because Slow Stochastics are smoother and are less likely to give false signals.

The most common uses of Stochastics are to:

- Indicate overbought and oversold conditions

An overbought or oversold market is one where the prices have risen or fallen too far and are therefore likely to retrace. If the %D line is above 80% then the close is near the top end of the range of the observation period, while a reading below 20% means that the close is near the bottom end of the range of the observation period. Generally the area above 80 is considered overbought, while the area below 20 is oversold. The specified overbought/oversold ranges vary. Other commonly used ranges include 75-25, 70-30 and 85-15. Overbought and oversold signals are most reliable in a non-trending market where prices are making a series of equal highs and lows. If the market is trending, then signals in the direction of the trend are likely to be more reliable.

For example if prices are in a downtrend, a safer trade entry may be obtained by waiting for prices topullback giving an overbought signal and then turn down again.

- Generate buy and sell signals

For a buy or sell signal the following conditions must be met in order.

1. The %K and %D lines move above 80 or below 20

2. The %K and %D lines cross

3. The %K and %D lines move below 80 or above 20

- Indicate Bullish and Bearish Divergence

Divergence between Stochastics and the price indicates that an up or down move is weakening. Bearish Divergence occurs when prices are making higher highs but the Stochastics are making lower highs. This is a sign that the up move is weakening. Bullish Divergence occurs when prices are making lower lows but the Stochastics are making higher lows. This is a sign that the down move is weakening.

Parameters

Observation period for %K Fast: (default 5)

Fast %K is used to calculate Slow %K, but is not charted.

Averaging period for %K Slow: (default 5)

This is the same as the%D Fast in Fast Stochastics. The averaging period is the number of observations of %K Fast used in the moving average.

Averaging period for %D Slow: (default 3)

This is the number of observations used in the moving average of %K Slow. The smaller the value the closer the %D will be to the %K.

12. Standard Deviation

A measure of dispersion of a set of data from their mean. The more spread apart the data is, the higher the "deviation". In statistics is can also be calculated as the square root of the variance A. Volatile price would have a high standard deviation. In mutual funds, the standard deviation tells us how much the return on the fund is "deviating" from the expected normal returns.

13. STOCHASTIC

Fast Stochastics consists of two lines, %K and %D:

The %K line measures, as a percentage, where the current close is, in relation to the lowest low over the observation period. This is shown on a scale of 0 to 100, where 0 is the observation period low, and 100 is the observation period high.

The %D line is a Simple Moving Average of the %K. Because it is a moving average, this line is smoother than the %K and provides the signals for an overbought / oversold market. Fast Stochastics are more sensitive than Slow Stochastics and therefore more likely to give false signals. As a result Fast Stochastics are less commonly used than Slow Stochastics.

The most common uses of Stochastics are to:

- Indicate overbought and oversold conditions

If the market is trending, then signals in the direction of the trend are likely to be more reliable. For example if prices are in an up trend, a safer trade entry may be obtained by waiting for prices to pullback giving an oversold signal and then turn up again.

- Generate buy and sell signals

For a buy or sell signal the following conditions must be met in order.

1. The %K and %D lines move above 80 or below 20

2. The %K and %D lines cross

3. The %K and %D lines move below 80 or above 20

- Indicate Bullish and Bearish Divergence

Bullish Divergence occurs when prices are making lower lows but the Stochastics are making higher lows. This is a sign that the down move is weakening. It is important to note that although Divergences indicate a weakening trend they do not in themselves indicate that the trend has reversed. The confirmation or signal that the trend has reversed must come from price action, for example a trend line break.

Parameters

Observation Period for %K FAST: (default 5)

The number of intervals in the period used for selecting the high and low. A value greater than the default results in a smoother less sensitive %K Fast line.

Averaging period for %D FAST: (default 3)

The averaging period is the number of observations of %K FAST lines used in the moving average. The smaller the value, the closer the %D will be to the %K.

14. WILIAMS %R

Developed by Larry Williams, Williams %R is a momentum indicator that works much like the Stochastic Oscillator. It is especially popular for measuring overbought and oversold levels. The scale ranges from 0 to -100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold.

William %R, sometimes referred to as %R, shows the relationship of the close relative to the high-low range over a set period of time. The nearer the close is to the top of the range, the nearer to zero (higher) the indicator will be. The nearer the close is to the bottom of the range, the nearer to -100 (lower) the indicator will be. If the close equals the high of the high-low range, then the indicator will show 0 (the highest reading). If the close equals the low of the high-low range, then the result will be -100 (the lowest reading).

The most common uses of Williams %R are :

One method of using Williams %R might be to identify the underlying trend and then look for trading opportunities in the direction of the trend. In an up trend, traders may look to oversold readings to establish long positions. In a downtrend, traders may look to overbought readings to establish short positions.

Indicate Bullish and Bearish Divergence

Divergence between Williams %R and the price indicates that an up or down move is weakening. Bearish Divergence occurs when prices are making higher highs but the Williams %R is making lower highs. This is a sign that the up move is weakening.

Bullish Divergence occurs when prices are making lower lows but the Williams %R is making higher lows. This is a sign that the down-move is weakening.