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Technical analysis presupposes studying internal information of stock exchange. The word "technical" means studying the market itself, instead of external factors expressed in market dynamics. All necessary factors whatever they were could be reduced to stock exchange trading volume and stock price levels or, generally, to an amount of statistical information received as a result of market activities research.
The main concept, on which the technical analysis is built, is that price movement has already reflected all information, which is published in company reports and becomes an object of industry analysis and analysis of financial condition of the issuer only later.
Technical analysis followers support a view, according to which such internal market parameters as trading volume and price frequently disclose future directions of market development before they are realized through financial parameters. Technical analysis mostly reflects changes in supply and demand and reveals any shifts in this direction.
Technical analysis methodology is based on the assumption that there are historically formed laws existing at the stock exchange. If certain actions undertaken in the past have resulted in certain events in nine cases out of ten, it is rather probable that the same effect will be achieved in the future no matter when such actions are taken. It is necessary to stress, however, that methods used in technical analysis quite often bear empirical character.
The given description of technical indicators defines each of them, provides their mathematical expression, interpretation, and practical use in the market analysis.
ATR (Average True Range)
DMI (ADX, DI+, DI-) (Directional Movement Indicator)
EMA (Exponential Moving Average)
Fast Stochastic
MACD (Moving Average Convergence/Divergence)
Momentum
RSI (Relative Strength Index)
Slow Stochastic
SMA (Simple Moving Average)
WMA (Weighted Moving Average)
ATR (Average True Range) - price average true range indicator |
ATR is a market volatility parameter. This indicator frequently reaches high values during price drops accompanied with "panic sellouts".
ATR - is typically a simple moving average of true ranges TR for a certain number of periods:
ATR = MA_type (TR, Period), where TR is a positive number determined as the greatest of three components:
- Differences between maximal and a minimal price for the current period.
- Module of difference between the previous period's closing price and maximum price for the current period.
- Module of difference between the previous period's closing price and minimal price for the current period.
One of the following moving average types can be used to smooth the price true range: EMA, SMA, TMA, WMA.
Low indicator values frequently correspond to lengthy periods of horizontal movement, which are observed at the price tops and during consolidation. It can be interpreted by the same rules as other volatility indicators. The principle of forecasting with this indicator is formulated as follows: the higher the indicator value, the higher probability of trend reversal, the lower its value, the weaker the trend's direction.
Parameters by default:
MA_type =SMA - moving average type for TR smoothing (SMA - Simple Moving Average);
Period=14 - moving average period for TR smoothing.
DMI (Directional Movement Indicator) - directional movement index |
DI+, DI- directional indicators
ADX (Average Directional Movement Index) - average movement indicator
The directional movement system (Directional Movement) helps to determine presence of price trend.
DMI research is carried out on one chart displaying DI +, DI-, ADX.
The basis of the directional movement system is formed by lines of 14-days positive and negative directional indicators (DI +, DI-). In the advancing market, DI+ will be increasing, while DI- will be decreasing. When the trend is strong and fast, appropriate DI movement will be equally strong and fast. When DI+ and DI- overlap, there is balance in the market, and the price moves sideways.
The market trend changes at DI crossing: if DI+ crosses DI- upwards, there is bullish situation in the market, while, on the contrary, if DI + falls below DI-, it means that sellers have become more active, and the market is ready to move downwards. Therefore, DI lines crossings can be regarded as trading signals.
When calculating ADX, first DX is computed, which is equal to ratio of difference between DI + and DI-, to sum of DI + and DI-, then multiplied by 100. This index determines percentage of directional movement in the entire movement. It allows expressing the trend strength as a value ranging from 0 to 100, regardless of whether the trend is directed upwards or downwards.
ADX is a DX smoothed down by exponential average. ADX, as displayed on chart, goes upwards when DI+ it is greater than DI-. If DI+ it is less than DI-, ADX movement is directed downwards. Therefore, the greater is ADX, the stronger trend is present in the market. Accordingly, the lesser is ADX, the less directed is the market movement (direction could be either upwards, or downwards). For example, in the falling market ADX can be confidently growing, signaling not direction, but strength of the trend.
One of the following moving average types can be used to smooth positive, negative directional movement, true range and directional movement: EMA, SMA, TMA, WMA.
Parameters by default:
MA_type =EMA - moving average type for smoothing positive, negative directional movement, true range, and directional movement (EMA - Exponential Moving Average);
Period_1=14 - moving average period for smoothing positive, negative directional movement and true range;
K= 2/(Period_1+1) - formula for exponential smoothing constant calculation;
Period_2=14 - moving average period for directional movement smoothing.
EMA (Exponential Moving Average) - exponential moving average |
Moving average shows average price value for a certain period of time.
There are several moving average types. The only thing, by which moving averages of different types differ from each other essentially, is different weight coefficients applied to the latest data.
Exponential moving averages assign greater weight to the latest prices.
Exponential moving average is calculated according to the formula:
where:
- exponential moving average value of the i (current) period;
- exponential moving average value of (i-1) (previous) period;
- i (current) value of analyzed series (usually Close prices series);
- smoothing constant, equal to 2 / (Period+1) or 2/Period; usually K=2/(Period+1);
Period - number of periods for moving average calculation.
The following are series for exponential moving average smoothing: Open, Lo, High, Close, (Open+Low+High+Close)/4, Volume.
As formulas for exponential smoothing constant K calculation, one of the following is offered:
2/(Period+1) or 2/Period.
Parameters by default:
Series_type=Close - series type to be smoothed (Close - closing prices series);
Period=10 - moving average period for series smoothing;
K= 2/(Period+1) - formula for exponential smoothing constant calculation.
Fast Stochastic, Slow Stochastic - fast, slow stochastic oscillator |
Stochastic oscillator compares the current closing price with price range for a selected period of time.
Stochastic oscillator is represented by two lines.
The main one is referred to as "%K". The second one, called "%D", is moving average of %K.
To calculate stochastic oscillator, the following variables are used.
- %K_Periods - It is the period of time used in stochastic calculation.
- period - Variable showing %K smoothing.
If it is equal to 1, it is considered that it is a fast stochastic.
In case it is equal to 3, it is considered that it is a slow stochastic.
- %D_Periods - Period of time used to calculate moving average of %K.
- MA_type - Moving average type (usually simple) used for %D calculation.
Actually %K compares position of price as against price range for a certain period.
D% plays the same role as signal line in MACD, i.e. triggers buy signal when %K crosses %D line upwards. Sell signal is triggered when %K line crosses %D downwards.
All possible values are located in the range from 0 to 100. When plotting indicator on chart, two signal levels are set (20 and 80), whose crossing by the indicator lines tells about the market being overbought/oversold.
One of the following moving average types can be used for fast and slow stochastic oscillator component calculation: EMA, SMA, TMA, WMA.
Default parameters for fast stochastic:
%K_Periods=10 - period for maximal, minimal, and closing prices calculation;
MA_type =SMA - moving average type for %K Fast Stochastic component smoothing (SMA - Simple Moving Average);
%D_Periods=10 - moving average period for %K Fast Stochastic component smoothing.
Default parameters for slow stochastic:
%K_Periods=10 - period for maximal, minimal, and closing prices calculation;
period=3 - number of periods for averaging differences between closing prices and minimal prices and between maximal and minimal prices;
MA_type =SMA - moving average type for %K Slow Stochastic component smoothing (SMA - Simple Moving Average);
%D Periods=10 - moving average period for %K Slow Stochastic component smoothing.
MACD ("Moving Average Convergence/Divergence") - moving average convergence/divergence indicator. |
MACD is a trend-following dynamic indicator being a difference between two, usually exponential, moving averages of closing prices - 12-period and 26-period.
As signal line for MACD, serves its 9-period exponential moving average.
There are two graphic forms of MACD presentation - that of linear and histogram.
In case of linear presentation, MACD is displayed as a continuous line, while signal line as a dotted line.
Histogram represents difference between MACD and its signal line.
This indicator is most effective during big amplitude of price swings in a trading range.
The most frequently used MACD signals are crossings, overbought/oversold condition, and divergences.
- Crossings.
Key rule of trading with MACD is indicator crossing with its signal line: sell when MACD falls below signal line, and buy when it rises above signal line. MACD crossings above/below zero line are also used as trading signals.
In histogram presentation, trading signals are formed in points of MACD crossing above/below zero line.
- Overbought/oversold.
MACD is rather valuable as the market overbought/oversold indicator. When MACD grows (i.e. short moving average rises faster than the long one), it means that the stock price is most likely too overvalued, and correction will be developing shortly.
- Divergences.
In case of divergence occurring between the price and MACD, it can mean a possibility of the current trend oncoming reversal.
Divergences are most valuable in case of their formation in overbought/oversold areas.
One of the following moving average types can be used for fast and slow moving average calculation, as well as for signal line calculation: EMA, SMA, TMA, WMA.
Parameters by default:
MA_type =EMA - moving average type for price series smoothing (EMA - Exponential Moving Average);
SlowPeriod=26 - period for slow moving average calculation;
FastPeriod=12 - period for fast moving average calculation;
SignalPeriod=9 - period to smooth difference between fast and slow moving average (signal line)
K= 2/(Slow(Fast or Signal)Period+1) - formula for exponential smoothing constant calculation.
Presentation type - linear (difference between fast and slow moving averages and signal line difference).
Momentum - momentum indicator |
Momentum indicator shows amount of price change for some period of time. This indicator is calculated as a ratio of the current closing price and closing price several periods back:
where:
- momentum indicator value for the current i-period;
- closing price of the current i-period;
- closing price (i - Period_1) -periods back;
- period for momentum indicator calculation.
How to use Momentum.
Momentum indicator can be used as trend following oscillator, similarly to MACD. In that case, buy signal is triggered if the indicator falls to the trough and begins to grow, and sell signal is triggered, if the indicator reaches the peak and turns downward. To pinpoint the indicator turning moments more precisely, its short moving average could be used.
Momentum indicator can be used as a leading indicator, too. This method is based on the assumption that the final phase of uptrend is usually associated with price rally (since everyone believes in its continuation), while bear market ending is associated with sharp price drop (since everybody is trying to get out of the market). That's how it happens quite often, but still this is a generalization too wide.
One of the following moving average types can be used to smooth the Momentum indicator: EMA, SMA, TMA, WMA.
Parameters by default:
Period_1=12 - period for Momentum calculation;
MA_type =SMA - moving average type for Momentum smoothing (SMA - Simple Moving Average);
Period_2=1 - moving average period for Momentum smoothing.
RSI (Relative Strength Index) - relative strength index |
RSI is one of the most popular oscillators.
This indicator, perhaps, could be better called "internal strength index" since it shows not relative strength of two stocks being compared, but internal strength of one security.
The indicator is calculated as follows:
where:
- relative strength index;
- smoothed (usually with simple moving average) values of closing price increment series;
- smoothed (usually with simple moving average) values of closing price decrease series.
RSI is a trend following oscillator fluctuating in the range from 0 to 100. 20 and 80 are considered control levels and are signals of the stock's overbought/oversold condition.
One of the most widely used methods of RSI analysis consists in looking for divergences when the price forms a new maximum, while the indicator fails to break the previous maximum level. Such divergence tells about probability of price reversal. If RSI then turns downwards and falls below its previous bottom, it completes the so-called "failure swing". This failure swing is considered as confirmation of oncoming price reversal.
Besides, RSI graphic patterns are plotted (triangles, "head and shoulders") which can be invisible on the price chart.
Also, when plotted on RSI chart, support and resistance levels sometimes appear better than on the price chart.
One of the following moving average types can be used to smooth closing price advance and decline series: EMA, SMA, TMA, WMA.
Parameters by default:
MA_type =SMA - moving average type for price advance and decline series smoothing (SMA - Simple Moving Average);
Period=14 - moving average period for price advance and decline series smoothing.
SMA (Simple Moving Average) - simple moving average |
Moving average shows average value of the price for some period of time.
To calculate moving average, mathematical averaging of the stock price for the given period is made. In the process of price changing, its average value either grows, or falls.
Moving averages can be calculated for any consecutive data set, including opening, closing, minimal, and maximal prices, as well as other indicator values.
There are several moving average types. The only thing making moving averages different from each other is that they use different weights applied to the most recent data. In case of simple moving average all prices of the period considered have equal weight.
Simple moving average is calculated according to the following formula:
where:
- (current) period simple moving average value;
- -value of analyzed series (usually Close prices series);
- value of analyzed series (usually Close prices series).
The most widespread method of moving average interpretation consists in comparing dynamics of the price and its moving average. When the stock price rises above the MA, buy signal is triggered, while when the price falls below, it triggers sell signal.
Currently, the most widely used methods are based on two and more moving averages.
MA can be applied to indicators as well. Indicator MA interpretation is similar to price moving average interpretation.
The following series could be used for smoothing with simple moving averages: Open, Lo, High, Close, (Open+Low+High+Close)/4, Volume.
Parameters by default:
Series_type =Close - series type to be smoothed (Close is closing price series);
Period=15 - moving average period for series smoothing.
WMA (Weighted Moving Average) - weighted moving average |
Moving average shows average value of the price for some period of time.
To calculate moving average, mathematical averaging of the stock price for the given period is made. In the process of price changing, its average value either grows or falls.
Moving average can be calculated for any consecutive data set, including opening, closing, minimal, and maximal prices, as well as other indicator values.
There are several moving average types. The only thing making moving averages different from each other is that they use different weights applied to the most recent data. In case of weighted moving average, each value of the series is "weighed" according to its position in the time series.
Weighed moving average is calculated according to the following formula:
where:
- (current) period weighed moving average value;
- - value of analyzed series (usually prices series);
- complete number of periods for moving average calculation;
- number of period, for which moving average with length is being calculated.
The most widespread method of moving average interpretation consists in comparing dynamics of the price and its moving average. When the stock price rises above the MA, buy signal is triggered, while when the price falls below, it triggers sell signal.
Currently, the most widely used methods are based on two and more moving averages.
MA can be applied to indicators as well. Indicator MA interpretation is similar to price moving average interpretation.
The following series can be used for smoothing with weighted moving averages: Open, Lo, High, Close, (Open+Low+High+Close)/4, Volume.
Parameters by default:
Series_type =Close - series type to be smoothed (Close is closing price series);
Period=15 - moving average period for series smoothing.
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