Commodity Channel Index
December 25, 2008
Definition:
The value of the Commodity Channel Index (CCI) is not limited to commodities, and was developed by Donald Lambert as a market timing tool, designed to keep trades neutral in a sideways moving market, and identify entry points when a breakout occurs. Specifically, this oscillator measures how high or low prices are relative to their statistical mean. A high value means prices are relatively high and while a low value means the opposite. An oscillator refers to a momentum or rate-of-change indicator that is usually valued from -1 to +1 or 0% to %100.
The CCI is often best-suited for securities with cyclical patterns, with an optimal period being at least less than 1/3 the number of periods of the cycle.
Interpretation:
The Commodity Channel Index can be interpreted in several different ways, and can be incorporated into many different types of trading schemes or philosophies depending on the type of security and the periods being analyzed.
One interpretation is to use CCI as an overbought/oversold oscillator, meaning that when CCI is in its upper ranges, extending beyond +100, CCI is overbought and a price correction is forthcoming. When CCI is well into its lower ranges, extending below -100, a price rally is approaching.
A second interpretation is that when the CCI breaks into triple digits it will continue a trend.
- When the CCI rises above +100, it is a bullish signal.
- When the CCI dips below -100, it is a bearish signal.
Critics of the indicator say that CCI often misses the early part of the price movement. To overcome this, some traders use signals when the CCI crosses the zero.
- When CCI crosses zero from negative to positive, it is potentially a bullish signal.
- When CCI crosses zero from positive to negative, it is potentially a bearish signal.
A third interpretation is to integrate the two views, and look for divergences as the distinguishing factor. For instance, if the price is breaking new highs, as the CCI is not, the security is potentially oversold, whereas is both are reaching new highs, then an uptrend will possibly ensure. The reverse conditions can hold true when the price reaches new lows over a given period.
Chaikin Money Flow
December 25, 2008
Definition:
Like the popular Chaikin A/D Oscillator developed by Marc Chaikin, the Chaikin Money Flow indicator is based on the Accumulation/Distribution line. It is created by summing the values of the Accumulation/Distribution Line for 21 periods and then dividing by a 21 period sum of the volume.
Interpretation:
The interpretation of the Chaikin Money Flow indicator is based on the assumption that market strength is usually accompanied by prices closing in the upper half of their daily range with increasing volume. Likewise, market weakness is usually accompanied by prices closing in the lower half of their daily range with increasing volume.
If prices consistently close in the upper half of their daily high/low range on increased volume, then the indicator will be positive (i.e., above the zero line). This indicates that the market is strong. Conversely, if prices consistently close in the lower half of their daily high/low range on increased volume, then the indicator will be negative (i.e., below the zero line). This indicates that the market is weak.
The Chaikin Money Flow indicator provides excellent confirmation signals of trendline and support/resistance breakouts. For example, if a security’s prices have recently penetrated a downward sloping trendline (signalling a potential trend reversal), you may want to wait for further confirmation by allowing the Chaikin Money Flow indicator to cross above the zero line. This may indicate an overall shift from a downtrend to a new uptrend.
A divergence between the Chaikin Money Flow indicator and prices are also significant. For example, if the most recent peak of the indicator is lower than it’s prior peak, yet prices are continuing upward, this may indicate weakness.
Breadth Advance/Decline
December 25, 2008
Definition:
The Breadth Advance/Decline is a market breadth indicator developed by Martin Zweig. It is an indicator designed to track the momentum of the broader market and anticipate large upswings or downswings in price. This is based on the concept that the number of advancing securities accompanying a market rise is positively correlated with the probability for further advances. Likewise, the number of declining issues pushing the market downward can be correlated with the probability for further declines. The Breadth Advance/Decline is calculated by taking the 10 day simple moving average of the number of advancing issues and dividing that number by the sum of the total amount of advancing issues and the total amount of declining issues on the New York Stock Exchange. The neutral point of the Breadth Advance/Decline indicator is .500 in a range of zero to one.
Interpretation:
There are several common modes of interpretation for Breadth Advance/Decline.
One type of interpretation involves extremely bullish or bearish behavior. When the Breadth Advance/Decline goes above .66, it can be considered very bullish conditions. If it falls below, .37, it can be considered very bearish conditions. Other indicators can verify whether these conditions warrant an overbought/oversold market or whether the market will continue in its current trend.
A second type of interpretation involves the rapidity of a rise or decline in the indicator. A rapid decline (defined as approximately .2 with 10 days) can indicate that the market has shifted from a simply overbought market to one of true weakness, potentially forecasting a prolonged bear market. A steep increase (defined as approximately .2 within 10 days) can indicate that the market has shifted from an oversold market to one of robust strength, potentially forecasting an extended period of strong growth. Remember, the Breadth Advance/Decline studies the entirety of the NYSE, and not individual stocks.
A final type of interpretation involves a crossover of the neutral line.
When the indicator goes from negative to positive (crosses above .500) a bullish climate can be interpreted for the market, and confirmed by other indicators for individual stocks or industries.
When the indicator goes from positive to negative (crosses above .500) a bearish signal can be interpreted for the market, and confirmed by other indicators for individual stocks or industries.
Bollinger Bands
December 24, 2008
Definition:
Investors use trading bands, lines drawn above and below the moving average, to isolate a range of prices for a given security, based on the concept that a stock generally trades within a predictable range on either side of the moving average. When a stock is near the upper or lower limits of the trading bands is when an investor should pay closest attention, according to conventional wisdom.
Bollinger Bands are considered some of the most useful bands in technical analysis, for they vary in distance from the moving average of a security\’s price based on the security\’s volatility. During periods of increased fluctuation, the bands widen to take this into account, and when the fluctuation decreases, the bands are tapered for a narrower focus to the price range. The upper band is the standard deviation multiplied by a given factor above the simple moving average, and the lower band is the standard deviation multiplied by the same given factor below the simple moving average.
Interpretation:
The standard interpretation is that Bollinger Bands do not give absolute buy and sell signals, but instead indicate whether the price is relatively high or low, allowing for more informed confirmation with other technical indicators.
Bollinger Bands are typically drawn two standard deviations from a twenty day simple moving average for intermediate-term analysis, ten day for short term with 1.5 standard deviations, and fifty for long-term studies with 2.5 standard deviations. According to John Bollinger, for the most accurate average “choose one that provides support to the correction of the first move up off a bottom. If the average is penetrated by the correction, then the average is too short. If, in turn, the correction falls short of the average, then the average is too long. An average that is correctly chosen will provide support far more often than it is broken.”
Mr. Bollinger also contends that:
- Sharp moves tend to occur after the bands tighten to the average, when a stock is less volatile. The greater the period of less volatility, the higher the propensity for a price breakout.
- When the price hits the upper or lower bands, it is suggested to confirm with other indicators whether that price movement shows strength or weakness, respectively, which could indicate a continuation. If indicators do not confirm this movement, it can suggest a reversal.
- Tops or bottoms made outside the bands, followed by the same inside the bands, indicate a trend reversal.
- A move originating at one band tends to go to the other band.
BB Bollinger Bands Squeeze
December 24, 2008
Definition:
Known as the BB Squeeze Indicator, its concept is based on capturing breakout moves by using the Bollinger Bands outside the Keltner Channels.
Whenever the Bollinger Bands fall inside the Keltner Channels the indicator will fire a signal. This signal is represented by a red dot on the lower pane.
When the Bollinger Bands breakout of the Keltner Channels the indicator fires a squeeze indicated by a green dot on the lower pane.
Interpretation:
The trading signal is taken when the green dot appears after the red dot in the direction of momentum. Momentum is plotted as a histogram. If the momentum is blue (up) on a squeeze, this is a long signal. If the momentum is red (down) on a squeeze, this is a short signal.
Average True Range
December 24, 2008
Definition:
Average True Range is a measure of volatility, and is measured by taking a moving average of the greatest value of the following:
- The distance between this period’s high & low,
- The distance from last period’s close to this period’s high or
- The distance from last period’s close to this period’s low
Interpretation:
Like other indicators that measure volatility, the conventional interpretation is for high periods or peaks in ATR to sometimes be considered clues that investors are having a bull vs. bear struggle, perhaps signalling that a top or bottom is approaching.
During low periods or valleys in ATR, some investors consider this a sign of consolidation or sideways periods.
For certain volatility studies (because the value of Average True Range is expressed as an average of the distance between two prices rather than a percentage), the value of the ATR should not only be considered relative to itself, but also relative to the price of the stock.
In other words, a change in ATR value from 2 to 3 for a $15 stock represents a move of Price/ATR from 13% to 20%. A change in ATR value from 2 to 3 on a $50 stock represents a move of Price/ATR from 4% to 6%.
The typical moving average used for Average True Range is 14, which matches the default value in IQ Chart. A higher moving average might be used for long-term study while a shorter moving average can be used for very short-term study.
Accumulation/Distribution
December 24, 2008
Definition:
The Accumulation/Distribution is a momentum indicator that associates changes in price and volume. The indicator is based on the premise that the more volume that accompanies a price move, the more significant the price move.
Interpretation:
The Accumulation/Distribution is really a variation of the more popular On Balance Volume indicator. Both of these indicators attempt to confirm changes in prices by comparing the volume associated with prices.
When the Accumulation/Distribution moves up, it shows that the security is being accumulated, as most of the volume is associated with upward price movement. When the indicator moves down, it shows that the security is being distributed, as most of the volume is associated with downward price movement.
Divergences between the Accumulation/Distribution and the security\’s price imply a change is imminent. When a divergence does occur, prices usually change to confirm the Accumulation/Distribution. For example, if the indicator is moving up and the security\’s price is going down, prices will probably reverse.
Acceleration Bands
December 24, 2008
Definition:
Price Headley’s Acceleration Bands serve as a trading envelope that factor in a stock’s typical volatility over standard settings of 20 or 80 bars. They can be used across any time frame, though Headley prefers to use them most across weekly and monthly timeframes as breakout indicators outside these bands, while using the shorter time frames to define likely support and resistance levels at the lower and upper Acceleration Bands. Acceleration Bands are plotted around a simple moving average as the midpoint, and the upper and lower bands are of equal distance from this midpoint.
Interpretation:
The principle of Acceleration is one of the most critical lessons that active traders must learn. Stock traders need to get the best bang for their buck. They desire to rotate capital to the best performing stocks quickly and then rotate out of those stocks when the acceleration period ends. The goal is to keep moving your capital into the best-performing stocks. And option buyers especially need to be in the best trending stocks, as the time lost while holding an option can best be overcome by stocks that move sharply in the anticipated direction. We want to achieve maximum movement in the stock over the least amount of time possible.
I started my trading career focused on trendlines as a way to buy stocks at important support points and sell stocks at resistance points. As my trading progressed, I noticed that the biggest winners were the stocks that broke out and never gave you a chance to buy them back at support. I\’ve learned that the best profits come from the parabolic stock moves. These are the stocks that don\’t give you easy chances to get into them - what some might call “runaway” situations.
Based on years of research and monitoring the profiles of these stocks, I noticed that these runaway stocks have several factors in common:
They are usually in growth industries, like technology, communications, biotechnology and health care.
Earnings are usually growing at very fast rates, typically 30% or more and many times at 100% or more.
Some amount of media debate about the company\’s future prospects - the best scenario is to find a stock that is getting attention for being “overvalued” - I often find that Acceleration Stocks often get more overvalued until the crowd recognizes the stock as a clear winner.
Usually there is a breakout to a new high over the prior 50-bar high - these breakouts have the most longevity in my experience. Most investors like to buy stocks near their 52-week low and hope it returns to the 52-week high. Historically, the studies I have done show that over 80% of the leaders for the next 12 months were typically within 15% of their highs when their upside breakouts began.
After studying many different indicators to find where this “breakout point” appeared to reside in most stocks, I developed my Acceleration Bands indicator. There are several things I can tell you about it here publicly (subscribers to my daily services get access to the actual Acceleration Bands formula):
Usually I am looking at the last 20 bars on the Acceleration Bands - on a daily chart this incorporates roughly the last month\’s trading activity, while on a weekly chart this covers 4-1/2 months and a monthly chart just over 1-1/2 years of price action.
The upper and lower Acceleration Bands are plotted equidistant from the simple 20-period simple moving average (the middle blue line in the charts below). A daily chart shows a 20-day moving average, and a weekly chart plots a 20-week moving average.
Acceleration Bands adjust for a stock\’s volatility - the more volatile the stock\’s price action over the last 20 periods, the wider the bands will be around the moving average.
Once I see two consecutive closes above the upper Acceleration Band, I get a buy signal - on trending stocks this will often lead to a major upside Acceleration move - on choppy trading range stocks, this will often be a headfake - I use historical data which I share with subscribers to show which stocks have performed the best (and the worst) based on several entry and exit rules.
One close back into the Acceleration Band signals a traditional exit of the trade, as the Acceleration period is now likely to end.
Abel Average
December 24, 2008
Definition:
The Abel Average was developed by Paul Abel and is a form of an “adaptive moving average” and is intended to provide buy and sell signals when prices break out of a range or break out of a sideways market. It is displayed as an overlay.
Formula:
Although the Abel average starts from the idea of tracking the average price over a given number of periods, it is intended to reduce the “trend-following” characteristics associated with typical moving averages.
Input: Periodicity
Constant: Yesterday\’s_Factor=(1/Periodicity), DragFactor=(1-Yesterday\’s_Factor)
Variables: DragValue
First bar: AbelAvg=(Open+Close)/2, and record AbelAvg and H,L,C for tomorrow\’s calc.
Second bar and thereafter…
DragValue=(Yesterday\’s_AbelAvg*DragFactor)
AbelAvg=(DragValue)+(Yesterday\’s_Low*Yesterday\’s_Factor)
Unless (Yesterday\’s_Close is less than Yesterday\’s_AbelAvg), in which case… AbelAvg=(DragValue)+(Y\’s_High*Yesterday\’s_Factor)
Interpretation:
Abel Averages can be interpreted like a moving average, but the conventional interpretation is that an upturn could be considered bullish and a downturn could be considered bearish.
Because it is designed to be less “trend-following” then many overlays, it does not need to wait for a crossover to price or another moving average according to some traders.
