MOVING AVERAGES

Most chart patterns show a lot of variation in price movement. This can make it difficult for traders to get an idea of a security's overall trend. One simple method traders use to combat this is to apply moving averages. A moving average is the average price of a security over a set amount of time. By plotting a security's average price, the price movement is smoothed out. Once the day-to-day fluctuations are removed, traders are better able to identify the true trend and increase the probability that it will work in their favor.

Types of Moving Averages:

There are a number of different types of moving averages that vary in the way they are calculated, but how each average is interpreted remains the same. The calculations only differ in regards to the weighting that they place on the price data, shifting from equal weighting of each price point to more weight being placed on recent data. The three most common types of moving averages are simple, linear and exponential.

Simple Moving Average (SMA)

This is the most common method used to calculate the moving average of prices. It simply takes the sum of all of the past closing prices over the time period and divides the result by the number of prices used in the calculation. For example, in a 10-day moving average, the last 10 closing prices are added together and then divided by 10. As you can see in below Figure, a trader is able to make the average less responsive to changing prices by increasing the number of periods used in the calculation. Increasing the number of time periods in the calculation is one of the best ways to gauge the strength of the long-term trend and the likelihood that it will reverse.

Many individuals argue that the usefulness of this type of average is limited because each point in the data series has the same impact on the result regardless of where it occurs in the sequence. The critics argue that the most recent data is more important and, therefore, it should also have a higher weighting. This type of criticism has been one of the main factors leading to the invention of other forms of moving averages.

Linear Weighted Average

This moving average indicator is the least common out of the three and is used to address the problem of the equal weighting. The linear weighted moving average is calculated by taking the sum of all the closing prices over a certain time period and multiplying them by the position of the data point and then dividing by the sum of the number of periods. For example, in a five-day linear weighted average, today's closing price is multiplied by five, yesterday's by four and so on until the first day in the period range is reached. These numbers are then added together and divided by the sum of the multipliers.

Exponential Moving Average (EMA)

This moving average calculation uses a smoothing factor to place a higher weight on recent data points and is regarded as much more efficient than the linear weighted average. Having an understanding of the calculation is not generally required for most traders because most charting packages do the calculation for you. The most important thing to remember about the exponential moving average is that it is more responsive to new information relative to the simple moving average. This responsiveness is one of the key factors of why this is the moving average of choice among many technical traders. As you can see in below Figure, a 15-period EMA rises and falls faster than a 15-period SMA. This slight difference doesn’t seem like much, but it is an important factor to be aware of since it can affect returns.
Major Uses of Moving Averages
Moving averages are used to identify current trends and trend reversals as well as to set up support and resistance levels.

Moving averages can be used to quickly identify whether a security is moving in an uptrend or a downtrend depending on the direction of the moving average. As you can see in below Figure, when a moving average is heading upward and the price is above it, the security is in an uptrend. Conversely, a downward sloping moving average with the price below can be used to signal a downtrend.

Another method of determining momentum is to look at the order of a pair of moving averages. When a short-term average is above a longer-term average, the trend is up. On the other hand, a long-term average above a shorter-term average signals a downward movement in the trend.

Moving average trend reversals are formed in two main ways: when the price moves through a moving average and when it moves through moving average crossovers. The first common signal is when the price moves through an important moving average. For example, when the price of a security that was in an uptrend falls below a 50-period moving average, like in below Figure, it is a sign that the uptrend may be reversing.


The other signal of a trend reversal is when one moving average crosses through another. For example, as you can see in below Figure, if the 15-day moving average crosses above the 50-day moving average, it is a positive sign that the price will start to increase.


If the periods used in the calculation are relatively short, for example 15 and 35, this could signal a short-term trend reversal. On the other hand, when two averages with relatively long time frames cross over (50 and 200, for example), this is used to suggest a long-term shift in trend.

Another major way moving averages are used is to identify support and resistance levels. It is not uncommon to see a stock that has been falling stop its decline and reverse direction once it hits the support of a major moving average. A move through a major moving average is often used as a signal by technical traders that the trend is reversing. For example, if the price breaks through the 200-day moving average in a downward direction, it is a signal that the uptrend is reversing.


Moving averages are a powerful tool for analyzing the trend in a security. They provide useful support and resistance points and are very easy to use. The most common time frames that are used when creating moving averages are the 200-day, 100-day, 50-day, 20-day and 10-day. The 200-day average is thought to be a good measure of a trading year, a 100-day average of a half a year, a 50-day average of a quarter of a year, a 20-day average of a month and 10-day average of two weeks.

Moving averages help technical traders smooth out some of the noise that is found in day-to-day price movements, giving traders a clearer view of the price trend. So far we have been focused on price movement, through charts and averages.

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AVERAGE TRUE RANGE (ATR)

Introduction

Developed by J. Welles Wilder and introduced in his book, New Concepts in Technical Trading Systems (1978), the Average True Range (ATR) indicator measures a security's volatility. As such, the indicator does not provide an indication of price direction or duration, simply the degree of price movement or volatility.

As with most of his indicators, Wilder designed ATR with commodities and daily prices in mind. In 1978, commodities were frequently more volatile than stocks. They were (and still are) often subject to gaps and limit moves. (A limit move occurs when a commodity opens up or down its maximum allowed move and does not trade again until the next session. The resulting bar or candlestick would simply be a small dash.) In order to accurately reflect the volatility associated with commodities, Wilder sought to account for gaps, limit moves, and small high-low ranges in his calculations. A volatility formula based on only the high-low range would fail to capture the actual volatility created by the gap or limit move.

Wilder started with a concept called True Range (TR) which is defined as the greatest of the following:

•The current High less the current Low.
•The absolute value of the current High less the previous Close.
•The absolute value of the current Low less the previous Close.

If the current high-low range is large, chances are it will be used as the True Range. If the current high-low range is small, it is likely that one of the other two methods would be used to calculate the True Range. The last two possibilities usually arise when the previous close is greater than the current high (signaling a potential gap down or limit move) or the previous close is lower than the current low (signaling a potential gap up or limit move). To ensure positive numbers, absolute values were applied to differences.

The example above shows three potential situations when the TR would not be based on the current high/low range. Notice that all three examples have small high/low ranges and two examples show a significant gap.

1.A small high/low range formed after a gap up. The TR was found by calculating the absolute value of the difference between the current high and the previous close.

2.A small high/low range formed after a gap down. The TR was found by calculating the absolute value of the difference between the current low and the previous close.

3.Even though the current close is within the previous high/low range, the current high/low range is quite small. In fact, it is smaller than the absolute value of the difference between the current high and the previous close, which is used to value the TR.

Note: Because the ATR shows volatility as an absolute level, low price stocks will have lower ATR levels than high price stocks. For example, a $10 security would have a much lower ATR reading than a $200 stock. Because of this, ATR readings can be difficult to compare across a range of securities. Even for a single security, large price movements, such as a decline from 70 to 20, can make long-term ATR comparisons difficult.

Calculation
Typically, the Average True Range (ATR) is based on 14 periods and can be calculated on an intraday, daily, weekly or monthly basis. For this example, the ATR will be based on daily data. Because there must be a beginning, the first TR value in a series is simply the High minus the Low, and the first 14-day ATR is the average of the daily ATR values for the last 14 days. After that, Wilder sought to smooth the data set, by incorporating the previous period's ATR value. The second and subsequent 14-day ATR value would be calculated with the following steps:

1.Multiply the previous 14-day ATR by 13.
2.Add the most recent day's TR value.
3.Divide by 14.

AVERAGE TRUE RANGE (ATR)

WILLIAMS %R

INTRODUCTION:

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).

Calculation

%R = [(highest high over ? periods - close)/(highest high over ? periods - lowest low over ? periods)] * -100



Typically, Williams %R is calculated using 14 periods and can be used on intraday, daily, weekly or monthly data. The time frame and number of periods will likely vary according to desired sensitivity and the characteristics of the individual security.

It is important to remember that overbought does not necessarily imply time to sell and oversold does not necessarily imply time to buy. A security can be in a downtrend, become oversold and remain oversold as the price continues to trend lower. Once a security becomes overbought or oversold, traders should wait for a signal that a price reversal has occurred. One method might be to wait for Williams %R to cross above or below -50 for confirmation. Price reversal confirmation can also be accomplished by using other indicators or aspects of technical analysis in conjunction with Williams %R.

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 uptrend, traders may look to oversold readings to establish long positions. In a downtrend, traders may look to overbought readings to establish short positions.

CUP & HANDLE CHART PATTERN

DOUBLE BOTTOM CHART PATTERN

OVERCOME GREED N FEAR

WILLIAMS %R

HEADS N SHOULDERS

STOCHASTIC OSCILLATOR

Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the location of the current close relative to the high/low range over a set number of periods. Closing levels that are consistently near the top of the range indicate accumulation (buying pressure) and those near the bottom of the range indicate distribution (selling pressure).

Calculation

%K = 100 X { RECENT CLOSE - LOWEST LOW (N) / HIGHEST HIGH (N) - LOWEST LOW (N) }

%D = 3 - PERIOD MOVING AVERAGE OF %K

(N) = NUMBER OF PERIODS USED IN CALCULATION

A 14-day %K (14-period Stochastic Oscillator) would use the most recent close, the highest high over the last 14 days and the lowest low over the last 14 days. The number of periods will vary according to the sensitivity and the type of signals desired. As with RSI, 14 is a popular number of periods for calculation.

Slow versus Fast versus Full

There are three types of Stochastic Oscillators: Fast, Slow, and Full. The Fast Stochastic Oscillator is made up of %K and %D. In order to avoid confusion between the two, I'll use %K (fast) and %D (fast) to refer to those used in the Fast Stochastic Oscillator, and %K (slow) and %D (slow) to refer to those used in the Slow Stochastic Oscillator. The driving force behind both Stochastic Oscillators is %K (fast), which is found using the formula provided above.

The Fast Stochastic Oscillator is plotted in the box just below the price plot. The thick black line represents %K (fast) and the thin red line represents %D (fast). Also called the trigger line, %D (fast) is a smoothed version of %K (fast). One method of smoothing data is to apply a moving average. To smooth %K (fast) and create %D (fast), a 3-period simple moving average was applied to %K (fast). Notice how the %K (fast) line pierces the %D (fast) line a number of times. To alleviate some of these false breaks and smooth %K (fast), the Slow Stochastic Oscillator was developed.

The Slow Stochastic Oscillator is plotted in the lower box: the thick black line represents %K (slow) and the thin red line represents %D (slow). To find %K (slow) in the Slow Stochastic Oscillator, a 3-day SMA was applied to %K (fast). This 3-day SMA slowed (or smoothed) the data to form a slower version of %K (fast). A close examination would reveal that %D (Fast), the thin red line in the Fast Stochastic Oscillator, is identical to %K (Slow), the thick black line in the Slow Stochastic Oscillator. To form the trigger line, or %D (slow) in the Slow Stochastic Oscillator, a 3-day SMA was applied to %K (Slow).

The Full Stochastic Oscillator takes three parameters. Just as in the Fast and Slow versions, the first parameter is the number of periods used to create the initial %K line and the last parameter is the number of periods used to create the %D (full) signal line. What's new is the additional parameter, the one in the middle. It is a "smoothing factor" for the initial %K line. The %K (full) line that gets plotted is a n-period SMA of the initial %K line (where n is equal to the middle parameter).

The Full Stochastic Oscillator is more advanced and more flexible than it's Fast and Slow cousins. You can even use it to duplicate the other versions. For example, a (14, 3) Fast Stochastic is equivalent to a (14, 1, 3) Full Stochastic and a (12, 2) Slow Stochastic is equal to a (12, 3, 2) Full Stochastic.

Readings below 20 are considered oversold and readings above 80 are considered overbought. However, Lane did not believe that a reading above 80 was necessarily bearish or a reading below 20 bullish. A security can continue to rise after the Stochastic Oscillator has reached 80 and continue to fall after the Stochastic Oscillator has reached 20. Lane believed that some of the best signals occurred when the oscillator moved from overbought territory back below 80 and from oversold territory back above 20.

Buy and sell signals can also be given when %K crosses above or below %D. However, crossover signals are quite frequent and can result in a lot of whipsaws.

One of the most reliable signals is to wait for a divergence to develop from overbought or oversold levels. Once the oscillator reaches overbought levels, wait for a negative divergence to develop and then a cross below 80. This usually requires a double dip below 80 and the second dip results in the sell signal. For a buy signal, wait for a positive divergence to develop after the indicator moves below 20. This will usually require a trader to disregard the first break above 20. After the positive divergence forms, the second break above 20 confirms the divergence and a buy signal is given.

STOCASTIC OSCILLATOR

FLOOR PIVOT POINT

PIVOTS POINTS

PIVOT POINT

Pivot Point is a technical indicators, pivot point is a method of calculating the support and resistance for a particular index/scrip for a particular time frame like daily, weekly or monthly basis. The pivot point changes at the end of every day for the next day depending on open, low, high & close values.

There are maily 4 types of Pivot Points :

1. Floor Pivot Points

2. Woodie's Pivot Points

3. Tom DeMark's Pivot Point

4. Camarilla Pivot Point

Floor Pivot Point:

Resistance Level 3 - Extreme bullish market condition generally created by news driven price shock. This is where a market is at an overbought condition and may offer a day trader a quick reversal scalp trade.

Resistance Level 2 - Bullish market price objective or target high number for a trading session. It generally establishes the high of a given time period. The market often sees significant resistance at this price level and will provide an exit target for long positions.

Resistance Level 1 - Mild bullish sessions or in consolidating trading periods, this often acts as the high of a given session. In a bearish market condition, prices will try to come close to this level but most times fail.

Pivot Point - This is the focal price level or the mean that is derived from the collective market data from the prior session's high, low and close. It is the strongest of the support and resistance numbers. Prices normally trade above or below this area before breaking in one direction or the other. As a general guideline, if the market opens above the primary pivot, be a buyer on dips. If the market opens below this level look to sell rallies.

Support Level 1 - Mild bearish to bullish projected low target number in light volume or low volatility sessions or in consolidating trading periods. Prices tend to reverse at or near this level in bullish market conditions but most times fall short of hitting this number.

Support Level 2 - Bearish market price objective or targeted low number. The market often sees significant support at or near this level in a bearish market condition and is a likely target level to cover shorts.

Support Level 3 - Extreme bearish market condition generally created by a news driven price shock. This level will act as the projected target low or support area. This is where a market is at an oversold condition and may offer a day trader a quick reversal scalp trade.

CALCULATING PIVOT POINTS

Resistance 3 = High + 2*(Pivot - Low)

Resistance 2 = Pivot + (R1 - S1)

Resistance 1 = 2 * Pivot - Low

Pivot = (High + Low + Close)/3

Support 1 = 2 * Pivot - High

Support 2 = Pivot - (R1 - S1)

Support 3 = Low - 2* (High - Pivot)

AVERAGE DIRECTIONAL INDEX (ADX)

AVERAGE DIRECTIONAL INDEX (ADX)
J. Welles Wilder developed the Average Directional Index (ADX) to evaluate the strength of a current trend, be it up or down. It's important to determine whether the market is trending or trading (moving sideways), because certain indicators give more useful results depending on the market doing one or the other.

The ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend.

ADX can also be used to identify potential changes in a market from trending to non-trending. When ADX begins to strengthen from below 20 and moves above 20, it is a sign that the trading range is ending and a trend is developing.

When ADX begins to weaken from above 40 and moves below 40, it is a sign that the current trend is losing strength and a trading range could develop.

Positive/Negative Directional Indicators

The ADX is derived from two other indicators, also developed by Wilder, called the Positive Directional Indicator (sometimes written +DI) and the Negative Directional Indicator (-DI).

When the ADX Indicator is selected, With the Default color, ADX is the thick black line with less fluctuation, +DI is green and -DI is red. +DI measures the force of the up moves and -DI measures the force of the down moves over a set period. The default setting is 14 periods, but users are encouraged to modify these settings according to their personal preferences.

In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Be careful, though; when a security is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be used in conjunction with other aspects of technical analysis.

The ADX combines +DI with -DI, and then smooths the data with a moving average to provide a measurement of trend strength. Because it uses both +DI and -DI, ADX does not offer any indication of trend direction, just strength. Generally, readings above 40 indicate a strong trend and readings below 20 a weak trend. To catch a trend in its early stages, you might look for stocks with ADX that advances above 20. Conversely, an ADX decline from above 40 might signal that the current trend is weakening and a trading range is developing.

ADX

CAMARILLA PIVOT POINT

CAMARILLA PIVOT PIONT

Discovered in 1989 by Nick Stott - a successful bonds trader - the Camarilla equation quite simply expounds the theory that markets - like most time series - have a tendency to revert to the mean. In other words, when markets have a very wide spread between the high and low of the day before, they tend to reverse and retreat back towards the previous day's close. This suggests that today's intraday support and resistance can be predicted using yesterday's volatility.

The Camarilla Equation is for experienced traders and involves you in trading both with and against the trend, using simple rules based around price penetration of the L3 and L4 levels at the bottom of the days range, or the H3 and H4 levels at the top of the day's range. It relies on the fact that success in intraday trading requires you to enter and exit trades with the backing of major support or resistance, the positioning of this resistance being determined by the equation. To use the Camarilla Equation, you enter yesterday's open, high, low and close. The calculation then gives you 8 levels of intraday support and resistance.

H4 = (H - L) X 1.1 / 2 + C

H3 = (H - L) X 1.1 / 4 + C

H2 = (H - L) X 1.1 / 6 + C

H1 = (H - L) X 1.1 / 12 + C

L1 = C - (H - L) X 1.1 / 12

L2 = C - (H - L) X 1.1 / 6

L3 = C - (H - L) X 1.1 / 4

L4 = C - (H - L) X 1.1 / 2

HOW TO USE CAMARILLA LEVELS:

I) If Open price is between H3 and L3

Wait for the price to go below L3 and then when it moves back above L3 then go long. Stoploss will be L4

Wait for the price to go above H3 and then when the price moves back below
H3 then go short. Stoploss will be H4

II) If Open price is between H3 and H4

When price moves above H4 go long. Stoploss when be H3

When the price goes below H3 then go short sell. Stopless will be H4

III) Open price is between L3 and L4

When price moves above L3 go long. Stoploss will be L4

When the price goes below L4 short sell. Stoploss will be L3

IV) If Open price is outside the H4 or outside the L4 then wait for the prices to come in range and trade accordingly.

TOM DEMARK'S PIVOT POINT

Tom DeMark's pivot points

This are not pivot points exactly, but predicted low and high of the period. To calculate DeMark's pivot points follow these rules:

If Close < Open(current) Then X = H + 2 X L + C
If Close > Opencurrent Then X = 2 X H + L + C
If Close = Opencurrent Then X = H + L + 2 X C
New High = X / 2 - L; New Low = X / 2 - H

WOODIE'S PIVOT POINT

WOODIE'S PIVOT POINT:

Woodie's pivot points are similar to floor pivot points, but are calculated in a somewhat different way, giving more weight to the Close price of the previous period. Use the following rules to calculate Woodie's pivot points:

Pivot (P) = (H + L + 2 X C) / 4

Resistance (R1) = (2 X P) - L

R2 = P + H - L

Support (S1) = (2 X P) - H

S2 = P - H + L

TRIX

Introduction

TRIX is a momentum indicator that displays the percent rate-of-change of a triple exponentially smoothed moving average of a security's closing price. It was developed in the early 1980's by Jack Hutson, an editor for Technical Analysis of Stocks and Commodities magazine. Oscillating around a zero line, TRIX is designed to filter out stock movements that are insignificant to the larger trend of the stock. The user selects a number of periods (such as 15) with which to create the moving average, and those cycles that are shorter than that period are filtered out.

The TRIX is a leading indicator and can be used to anticipate turning points in a trend through its divergence with the security price. Likewise, it is common to plot a moving average with a smaller period (such as 9) and use it as a "signal line" to anticipate where the TRIX is heading. TRIX line crossovers with its "signal line" can be used as buy/sell signals as well.


Calculation

To calculate TRIX, you must first pick a period with which to create an exponential moving average of the closing prices. For a 15-day period:

1.Calculate the 15-day exponential moving average of the closing price.
2.Calculate the 15-day exponential moving average of the moving average calculated in step #1.
3.Calculate the 15-day exponential moving average of the moving average calculated in step #2. You now have triple exponentially smoothed the moving average of closing prices, greatly reducing volatility.
4.Finally, calculate the 1-day percent change of the moving average calculated in step #3

Since TRIX measures the rate-of-change of closing prices, a positive TRIX value is interpreted as a steady rise in the closing price of a security. A positive TRIX is thus akin to a positive trending price, allowing the indicator to act as a buy signal whenever it crosses up above the zero line. Similarly, crossing below the zero line suggests the price is tending to close down at the end of each period, which can be a sell signal.

The "signal line" mentioned earlier is also a useful buy/sell indicator. Since the signal line period is shorter, a cross above it suggests that recent stock prices are closing much higher. A buy signal is triggered when TRIX crosses above its signal line, and a sell signal is triggered when TRIX crosses below its signal line. This method can generate false signals during sideways price movements, so it works best when prices are trending. It is therefore wise to use TRIX in tandem with other indicators for confirmation.

AROON

Introduction

Developed by Tushar Chande in 1995, Aroon is an indicator system that can be used to determine whether a stock is trending or not and how strong the trend is. "Aroon" means "Dawn's Early Light" in Sanskrit and Chande chose that name for this indicator since it is designed to reveal the beginning of a new trend.

The Aroon indicator system consists of two lines, 'Aroon(up)' and 'Aroon(down)'. It takes a single parameter which is the number of time periods to use in the calculation. Aroon(up) is the amount of time (on a percentage basis) that has elapsed between the start of the time period and the point at which the highest price during that time period occurred. If the stock closes at a new high for the given period, Aroon(up) will be +100. For each subsequent period that passes without another new high, Aroon(up) moves down by an amount equal to (1 / No of periods) x 100.

The formula for Aroon(up) is:
[ [ (No of periods) - (No of periods since highest high during that time) ] / (No of periods) ] x 100

For example, consider plotting a 10-period Aroon(up) line on a daily chart. If the highest price for the past ten days occurred 6 days ago (4 days since the start of the time period), Aroon(up) for today would be equal to ((10-6)/10) x 100 = 40.

Aroon(down) is calculated in just the opposite manner, looking for new lows instead of new highs. When a new low is set, Aroon(down) is equal to +100. For each subsequent period that passes without another new low, Aroon(down) moves down by an amount equal to (1 / No of periods) x 100.

The formula for Aroon(down) is :
[ [ (No of periods) - (No of periods since lowest low during that time) ] / (No of periods) ] x 100

Continuing the example above, if the lowest price in that same ten-day period happened yesterday (i.e. on day 9), Aroon(down) for today would be {(10-8)/10} x 100 = 20.

Aroon Oscillator :

A separate indicator called the Aroon Oscillator can be constructed by subtracting Aroon(down) from Aroon(up). Since Aroon(up) and Aroon(down) oscillate between 0 and +100, the Aroon Oscillator will oscillate between -100 and +100 with zero as the center crossover line.

The Aroon(up) and Aroon(down) are moving lower in close proximity, it signals that a consolidation phase is under way and no strong trend is evident. When Aroon(up) dips below 50, it indicates that the current trend has lost its upward momentum. Similarly, when Aroon(down) dips below 50, the current downtrend has lost its momentum. Values above 70 indicate a strong trend in the same direction as the Aroon (up or down) is under way.

The Aroon Oscillator signals an upward trend is underway when it is above zero and a downward trend is underway when it falls below zero. The farther away the oscillator is from the zero line, the stronger the trend.

Relative Strength Index (RSI)

Introduction:

Developed by J. Welles Wilder and introduced in his 1978 book, New Concepts in Technical Trading Systems, the Relative Strength Index (RSI) is an extremely useful and popular momentum oscillator. The RSI compares the magnitude of a stock's recent gains to the magnitude of its recent losses and turns that information into a number that ranges from 0 to 100. 14 is the standard number of periods used when calculating the RSI.

Overbought/Oversold

Generally, if the RSI rises above 30 it is considered bullish for the underlying stock. Conversely, if the RSI falls below 70, it is a bearish signal. Some traders identify the long-term trend and then use extreme readings for entry points. If the long-term trend is bullish, then oversold readings could mark potential entry points.

Divergences

Buy and sell signals can also be generated by looking for positive and negative divergences between the RSI and the underlying stock. For example, consider a falling stock whose RSI rises from a low point of (for example) 15 back up to say, 55. Because of how the RSI is constructed, the underlying stock will often reverse its direction soon after such a divergence. As in that example, divergences that occur after an overbought or oversold reading usually provide more reliable signals.

Centerline Crossover

The centerline for RSI is 50. Readings above and below can give the indicator a bullish or bearish tilt. On the whole, a reading above 50 indicates that average gains are higher than average losses and a reading below 50 indicates that losses are winning the battle. Some traders look for a move above 50 to confirm bullish signals or a move below 50 to confirm bearish signals.

RSI

BEARISH DARK CLOUD COVER PATTERN

BEARISH DARK CLOUD COVER PATTERN:

Bearish Dark Cloud Cover Pattern is a two-candlestick pattern signaling a top reversal after an uptrend or, at times, at the top of a congestion band. We see a strong white real body in the first day. The second day opens strongly above the previous day high (it is above the top of the upper shadow). However, market closes near the low of the day and well within the prior day’s white body at the end of the day.

Market goes up with an uptrend. Then we see a strong white candlestick followed by a gap suggesting that bulls retain the control. However, the rally does not continue. Market suddenly closes at or near the lows of the day so the second day body moving well into the prior day’s real body. Longs are shaken somehow and short sellers now have a benchmark to place a stop, which is at the new high of the second day.

If the black real body’s close penetrates deeper into the prior white real body, the chance for a top increases. There are some Japanese technicians who require more than a 50% penetration of the black day’s close into the white real body. If the black candlestick does not close below the halfway point of the white candlestick then it is better to wait for confirmation following the dark cloud cover; and even if it does, a confirmation may still be necessary. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day.

BEARISH KICKING PATTERN

BEARISH KICKING PATTERN:

A White Marubozu is followed by a sharply lower gap when it opens during the second day. The second day opening is even below the prior session’s opening (forming a Black Marubozu). Such a pattern is called a Bearish Kicking Pattern.

Bearish Kicking Pattern sends a strong signal suggesting that the market is now heading downward. The previous market direction is not important in this pattern unlike most other candlestick patterns. The market has been in a trend when prices gap down the next day in case of Bearish Kicking Pattern. The prices on the second day never enter into the previous day's range and we have a close with another gap.

Both of the candlesticks do not have shadows (or very small shadows if any). In other words both are Marubozu. The Bearish Kicking Pattern is similar to the Bearish Separating Lines Pattern except that instead of the open prices being equal, in the Bearish Kicking Pattern a gap occurs.

The Bearish Kicking Pattern is highly reliable but still a confirmation may be necessary, and this confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day.

BEARISH ABANDONED BABY PATTERN

BEARISH ABANDONED BABY PATTERN:

The Bearish Abandoned Baby Pattern is a very rare top reversal signal. It is basically composed of a Doji Star, which shows gaps (including shadows) from the prior and following sessions’ candlesticks.

Most of the three-day star patterns have similar scenarios. In an uptrend, the market seems still strong displaying a long white candlestick and opening with a gap on the second day. The trading in second day is within a small range and its closing price is equal or very near to its opening price. Now there is a sign of sale-off potential with reversal of positions. The trend reversal is confirmed by the black candlestick on the third day. Downward gap also supports the reversal.

The Bearish Abandoned Baby Pattern is quite rare. The reliability of this pattern is very high, but still a confirmation in the form of a black candlestick with a lower close or a gap-down is suggested.

BEARISH EVENING STAR PATTERN

BEARISH EVENING STAR PATTERN:

This is a major top reversal pattern formed by three candlesticks. The first candlestick is a long white body; the second one is a small real body that may be white. It is characteristically marked with a gap in higher direction thus forming a star. In fact, the first two candlesticks form a basic star pattern. Finally we see the black candlestick with a closing price well within first session’s white real body. This pattern clearly shows that the market now turned bearish.

The market is already in an uptrend when the white body appears which further suggests the bullish nature of the market. Then a small body appears showing the diminishing capacity of the longs. The strong black real body of the third day is a proof that the bears have taken over. An ideal Bearish Evening Star Pattern has a gap before and after the middle real body. The second gap is rare, but lack of it does not take away from the power of this formation.

The stars may be more than one, two or even three. The color of the star and its gaps are not important. The reliability of this pattern is very high, but still a confirmation in the form of a black candlestick with a lower close or a gap-down is suggested.

BEARISH EVENING DOJI STAR PATTERN

BEARISH EVENING DOJI STAR PATTERN:

This is a major top reversal pattern formed by three candlesticks. The first candlestick is a long white body; the second is a doji characterized by a higher gap thus forming a doji star. The third one is a black candlestick with a closing price, which is within the first day’s white real body. It is a meaningful top pattern.

The first white body, while the market is in an uptrend, shows the continuing bullish nature of the market. Then a Doji appears showing the diminishing power of the longs. The strong black real body on the third day proves that bears have taken over. An ideal Bearish Evening Doji Star Pattern has a gap before and after the middle real body. The second gap is rare, but lack of it does not take away from the power of this formation.

The Doji may be more than one, two or even three. Doji’s gaps are not important. The reliability of this pattern is very high, but still a confirmation in the form of a black candlestick with a lower close or a gap-down is suggested.

BEARISH THREE BLACK CROWS PATTERN

BEARISH THREE BLACK CROWS PATTERN:

The Bearish Three Black Crows Pattern is indicative of a strong reversal during an uptrend. It consists of three long black candlesticks, which look like a stair stepping downward. The opening price of each day is higher than the previous day's closing price suggesting a move to a new short term low.

The Bearish Three Black Crows Pattern is indicative of the fact that the market has been at a high price for too long and the market may be approaching a top or is already at the top. A decisive downward move is reflected by the first black candlestick. The next two days show further decline in prices due to profit taking. Bullish mood of the market cannot be sustained anymore.

The opening prices of the second and third days can be anywhere within the previous day's body. However, it is better to see the opening prices below the middle of the previous day's body. If the black candlesticks are very extended, one should be cautious about an oversold market.

The reliability of this pattern is very high, but still a confirmation in the form of a black candlestick with a lower close or a gap-down is suggested.

BEARISH THREE INSIDE DOWN PATTERN

BEARISH THREE INSIDE DOWN PATTERN:

The Bearish Three Inside Down Pattern is another name for the Confirmed Bearish Harami Pattern. The third day confirms the bearish trend reversal.

The first two days of this three-day pattern is a Bearish Harami Pattern, and the third day confirms the reversal suggested by Bearish Harami Pattern since it is a black candlestick closing with a new low for the three days.

The reliability of this pattern is very high, but still a confirmation in the form of a black candlestick with a lower close or a gap-down is suggested.

BEARISH THREE OUTSIDE DOWN PATTERN

BEARISH THREE OUTSIDE DOWN PATTERN:

The Bearish Three Outside Down Pattern is another name for the Confirmed Bearish Engulfing Pattern. The third day confirms the bearish trend reversal.

The first two days forms a Bearish Engulfing Pattern, and the third day confirms the reversal suggested by the Bearish Engulfing Pattern since it is a black candlestick closing with a new low for the three days.

The reliability of this pattern is very high, but still a confirmation in the form of a black candlestick with a lower close or a gap-down is suggested.

BEARISH UPSIDE GAP TWO CROWS PATTERN

BEARISH UPSIDE GAP TWO CROWS PATTERN:

The Bearish Upside Gap Two Crows Pattern is a three-candlestick pattern and it signals a top reversal. The first candlestick is a long white candlestick followed by a real body that gaps higher. Then another black real body appears, which opens above the second day’s open and closes under the second day’s close, completing the pattern

The market is in an uptrend and it displays a higher opening with a gap. However the new highs of the day cannot hold and the market forms a black candlestick. However the bulls still comfort themselves by the fact that the close on this black candlestick day is still above the prior day’s close. The third day however increases the bearish sentiment displaying another new high but failing to hold these highs until the close. Also the day closes below the prior day’s close, which is another bearish sign . So the following question becomes relevant. If the market is so strong, why the new highs fail to hold and why market closes lower? The answer is clear. Market is not now as strong as the bulls would like to believe.

The two black candlesticks of the pattern are the crows reminding ominous looking black crows atop a tree branch. Confirmation for the Bearish Upside Gap Two Crows Pattern may be mildly suggested. If in the fourth session prices fail to regain high ground, lower prices should be expected.

BEARISH DRAGONFLY DOJI

BEARISH DRAGONFLY DOJI PATTERN:

A Bearish Dragonfly Doji Pattern is a single candlestick pattern, which occurs at a market top or during an uptrend. The Bearish Dragonfly Doji Pattern is very similar to the Bearish Hanging Man Pattern as mentioned above. In the case of Bearish Dragonfly Doji Pattern, the opening and closing prices are identical whereas the Bearish Hanging Man Pattern is characterized by a small real body at the upper end of the trading range.

The market is in a bullish mood characterized by an uptrend. Then we see a price action characterized by a sharp sell off when it opens. Prices move down going much lower than the opening price. Then we see a rally in the closing hours of the day, which closes the day at or very near the opening price. However this end-of- day rally signifies the potential for further sell offs. The long lower shadow shows how the market started the day with a sell off. If the market opens lower the next day, we may see a lot of longs eager to sell their positions.

The Bearish Dragonfly Doji Pattern is a more bearish pattern than the Bearish Hanging Man Pattern and it is also more reliable. Confirmation of the suggested trend reversal by either a black candlestick, a large gap down or a by a lower close on the next trading day is strongly advised.

BEARISH LONG LEGGED DOJI

BEARISH LONG LEGGED DOJI PATTERN:

Long Legged Doji is a doji characterized by very long shadows. It shows the indecision of the buyers and sellers and it is an important reversal signal.

This particular doji shows that there is a great amount of indecision in the market. Long-legged Doji shows that the prices traded well above and below the opening price however they closed virtually at the level of the opening price. We have an end result with little change from the initial open despite all the excitement and volatility during the day showing that the market has lost its sense of direction.

Long Legged Doji is more important at tops. Since the Long Legged Doji is a single candlestick pattern, it is better to see confirmation in the form of a move opposite to the prior trade on the next trading day.

BEARISH ENGULFING PATTERN

BEARISH ENGULFING PATTERN:

Bearish Engulfing Pattern is a large black real body, which engulfs a small white real body in an uptrend (it need not engulf the shadows). The Bearish Engulfing Pattern is an important top reversal signal.

Market is in a bull mood. Then we see diminished buying reflected by the short, white real body. This then is followed by a strong sell-off, which lead to a close at or below the previous day’s open. Apparently the uptrend has lost momentum and the bears may be gaining strength.

Relative sizes of the first and second days are important. If the first day of the Bearish Engulfing Pattern is a very small real body (it may even be almost a doji or is a doji) but the second day has a very long real body, this shows the dissipation of the prior uptrend’s force and an increase in bearish force.

A protracted or very fast move increases the chance that potential buyers are already long and that there may be less of a supply of new longs in order to keep the market moving up. A fast move makes the market overextended and vulnerable to profit taking. A Bearish Engulfing Pattern appearing after such a move is more likely to be an important bearish reversal indicator.
A bearish reversal is more possible if there is heavy volume on the second real body or if the second day of the Bearish Engulfing Pattern engulfs more than one real body.

A confirmation in the third day is required to be sure that the uptrend has reversed. The confirmation may be in the form of a black candlestick, a large gap down or a lower close on the third day.

BEARISH GRAVESTONE DOJI PATTERN

BEARISH GRAVESTONE DOJI PATTERN:

Gravestone Doji is a pattern in which the opening and closing prices are at the low of the day. The Bearish Gravestone Doji Pattern is a top reversal pattern. It appears during an uptrend representing a possible reversal of trend just like its cousin Bearish Shooting Star Pattern.

Gravestone Doji after a rally has bearish implications for the following reason. The market opens on the low of the day. Then prices start to rally (preferably to a new high). The rally cannot be sustained during the day and prices plummet to the day’s lows meaning trouble for longs. The Gravestone Doji represents the graves of those bulls that have died defending their territory.

The Bearish Gravestone Doji Pattern has more bearish implications than a Bearish Shooting Star Pattern. The longer the upper shadow and the higher the price level, the more bearish the implications of the Bearish Gravestone Doji Pattern will be.

A confirmation is required on the following day to be more certain about the bearish implications of the Bearish Gravestone Doji Pattern. Confirmation may be in the form of the next day opening below the Gravestone Doji. The larger the gap the stronger the confirmation will be. A black candlestick with lower prices can also be another form of confirmation.

BEARISH DOJI STAR PATTERN

BEARISH DOJI STAR PATTERN:

A short candlestick, a spinning top, a highwave or a doji following a white candlestick with an upside gap during an uptrend, is the Bearish Doji Star Pattern.

Bulls control the market in a strong uptrend. The appearance of a Bearish (Doji) Star Pattern in such an uptrend shows that buyers are now losing the control and market is moving to a deadlock between buyers and sellers. This deadlock or balance between buyers and sellers may result because of a diminition in the buying force or an increase in the selling force. Whatever the reason is, the star tells us that the strength of uptrend is now dissipating and the market is increasingly vulnerable to a setback.

A confirmation on the third day is required to convincingly show that the uptrend has reversed. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day.

BEARISH HARAMI CROSS PATTERN

BEARISH HARAMI CROSS PATTERN:

Bearish Harami Cross Pattern is a doji preceded by a long white real body. The Bearish Harami Cross Pattern is a major reversal pattern and is more significant than a regular Bearish Harami Pattern.

The Bearish Harami Cross Pattern is a sign of disparity about the market’s health. Market is bullish and strong buying continues as evidenced by the long, white real body but then we see the doji. This shows that the market may not continue in uptrend.

While the Bearish Harami Pattern is not a major reversal pattern, the Bearish Harami Cross Pattern is a major downside reversal pattern. If a harami cross appears after a long white candlestick, longs should take notice of it since Harami Crosses call tops very effectively.

A confirmation on the third day is required to be sure that the uptrend has reversed. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the third day.

BEARISH MEETING LINES PATTERN

BEARISH MEETING LINES PATTERN:

Market may gap up sharply as it opens but it closes unchanged from the prior session’s close during an uptrend. Such a pattern is called Bearish Meeting Lines Pattern, which is a pattern that reflects a balance between the bulls and the bears.

The Bearish Meeting Lines Pattern is a top reversal pattern suggesting a stall in uptrend. The first candlestick, a long white one, shows that the bullish momentum is going on. The next day opens higher with a gap but then the bears pull prices down to the prior day’s close. So the initial optimism on the second day’s opening now turns into concern of the longs.

The Bearish Meeting Lines Pattern is similar to the Bearish Dark Cloud Cover Pattern. The Dark Cloud Cover has the same two-candlestick pattern. The main difference between the two is the fact that the bearish counterattack line does not usually move into the prior session’s white real body. It just gets back to prior session’s close. The Bearish Dark Cloud Cover Pattern’s second line pushes well into the white real body. So the Dark Cloud Cover Pattern is a more important top reversal signal than the Bearish Meeting Lines Pattern.

A confirmation on third day is required to be sure that the uptrend has reversed. This confirmation may be in the form a black candlestick, a large gap down or a lower close on the third day.

BEARISH ADVANCE BLOCK PATTERN

BEARISH ADVANCE BLOCK PATTERN:

It is a pattern characterized by three long white candlesticks with consecutively higher closes during an uptrend. The Bearish Advance Block Pattern is similar to the Bullish Three White Soldiers Pattern. The difference is the fact that each successive day is weaker than the one preceding it. This may suggest that the rally is losing strength and a reversal is possible.
If the second and the third candlesticks (particularly the third) show signs of weakening, this means that the rally is losing steam and longs must consider protecting their positions. Longs need especially to be careful about the Bearish Advance Block Pattern during a mature uptrend. Signs of weakening are the progressively smaller white real bodies or the relatively long upper shadows on the latter two white candlesticks.

A definite deterioration in the upward strength is evidenced by long upper shadows on the second and third days.

The Bearish Advance Block Pattern is not normally a top reversal pattern, but it has the potential to precede a meaningful price decline. This pattern is more important at higher price levels. It suggests to liquidate long positions but it is yet early for short positions.

A confirmation of the reversal on the fourth day would provide the needed proof that the uptrend has reversed. A confirmation of the trend reversal by a black candlestick, a large gap down or by a lower close on the next trading day is suggested.

BEARISH DELIBERATION PATTERN

BEARISH DELIBERATION PATTERN:

The Bearish Deliberation Pattern is a derivative of the Bearish Three White Soldiers Pattern. This pattern also shows a weakness similar to the Bearish Advance Block Pattern since it becomes weaker in a short period of time. However here the weakness occurs all at once on the third day. The small third body of the pattern shows that the rally is losing strength and a reversal is possible.

The Bearish Deliberation Pattern appears after a sustained upward move and is suggestive of the fact that the rally is losing strength and a reversal is possible. The formation is a proof that the bulls’ strength is at least temporarily exhausted.

The last small white candlestick may show a gap away from the long white body, thus becoming a star, or it can be riding on the shoulder of the long white real body. The Bearish Deliberation Pattern is not normally a top reversal pattern but it has potential to precede a meaningful price decline. This pattern is more important at higher price levels. It must be used to liquidate long positions but it is yet too early for short positions.

A confirmation on fourth day is required to confirm that the uptrend has reversed. This may be in the form of a black candlestick, a large gap down or a lower close on the fourth day.

BEARISH TRI STAR PATTERN

BEARISH TRI STAR PATTERN:

The Bearish Tri Star Pattern is a very rare but significant top reversal pattern. It is formed by three Dojis. The middle Doji is a Doji Star.

The Bearish Tri Star Pattern appears in a market characterized by uptrend for a long time. When the trend starts to show weakness, we see smaller real bodies. The first Doji is already a matter of considerable concern. The second Doji shows that market now lost its direction. Finally, the third Doji announces the end of uptrend since this now shows utmost indecision leading to reversal of the positions.

A confirmation on the fourth day is required to show that the uptrend has reversed. This may be in the form of a black candlestick, a large gap down or a lower close on the fourth day.

BEARISH TWO CROWS PATTERN

BEARISH TWO CROWS PATTERN:

During an uptrend we see the market closing lower after an opening gap. Then we see a black day that fills the gap creating the Bearish Two Crows Pattern. It suggests the erosion of the uptrend, and warns about a possible trend reversal.

In the Two Crows bear pattern, the market is already in an extended uptrend. We see a gap in the opening of the second day. This higher opening is followed by a lower close in this second day warning that there is some weakness in the rally. The third day also opens at a higher price, but not above the open of the previous day, and then prices go down with a close well within the body of the first day. This third day action fills the gap of the second day. It shows that the bullishness started to erode quickly.

A confirmation on the fourth day is required to show that the uptrend has reversed. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the fourth day.

BEARISH BREAKAWAY PATTERN

BEARISH BREAKAWAY PATTERN:

We see this pattern during an uptrend marked with a bullish surge that eventually weakens. This weakening is illustrated by a long black candlestick that is unable to close the gap into the body of the first day. These events warn us about a short-term reversal.

The Bearish Breakaway Pattern is constituted by a gap in the direction of the uptrend followed by three consecutively higher price days. This shows that the trend has suddenly accelerated with a big gap but then it started to fizzle, however it still manages to move in the same direction. There is evidently a slow deterioration of the trend even though the uptrend continues. Finally, we see a burst in the opposite direction completely recovering the previous three days' price action. A possible reversal is also implied by the fact the gap has not been filled. We are now ready for a short-term reversal.

A confirmation on the sixth day is recommended in the form of a black candlestick, a large gap down or a lower close to be sure that there is indeed a reversal.

BEARISH BELT HOLT PATTERN

BEARISH BELT HOLT PATTERN:

The Bearish Belt Holt Pattern is a single candlestick pattern and it is basically a Black Opening Marubozu that occurs in an uptrend. The pattern shows that the day opens on its high, it then rallies against the trend of the market, and then closes near its low but not necessarily at its low. Longer bodies for Belt Hold are indicative of more resistance to the trend they are countering.

We have a market that is trending up when a significant gap in the direction of trend occurs as the day opens. However, then prices reverse direction and all further price action of the day is the opposite of the previous trend. Such a move causes concern among the bulls and leads them to sell many positions. This strengthens the reversal and turns into a sell-off.

A confirmation of the trend reversal with either a black candlestick, a large gap down or a lower close on the next trading day is required.

BEARISH HANGING MAN PATTERN

BEARISH HANGING MAN PATTERN:

The Bearish Hanging Man Pattern is a single candlestick and a top reversal pattern. It is very similar to the Bearish Dragonfly Doji Pattern. In case of the Bearish Dragonfly Doji Pattern, the opening and closing prices are identical whereas the Bearish Hanging Man Pattern has a small real body.

The hanging man is a bearish reversal pattern. It signals a market top or a resistance level. Since it is seen after an advance, a Bearish Hanging Man Pattern signals that selling pressure is starting to increase. The low of the long lower shadow indicates that the sellers pushed prices lower during the session. Even though the bulls regained their footing and drove prices higher by the finish, the appearance of this selling pressure after a rally is a serious warning signal.

Ideally, the lower shadow of the Bearish Hanging Man Pattern must be two or three times the height of the real body. However, a long lower shadow may not have to be twice the height of the real body in the real life conditions in order to signal a reversal. The pattern is more perfect if the lower shadow is longer.

The Bearish Dragonfly Doji Pattern is a more bearish signal than the Bearish Hanging Man Pattern and it is also more reliable than the Bearish Hanging Man Pattern.

If a Bearish Hanging Man Pattern is characterized by a black real body, it shows that the close was not able to get back to the opening price level, which has potentially bearish implications.

We need a confirmation of the reversal on the next day for a more definite proof about the reversal of the uptrend. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day.

BEARISH SHOOTING STAR PATTERN

BEARISH SHOOTING STAR PATTERN:

Bearish Shooting Star Pattern suggests that prices may be approaching to a top. It looks like its name, a shooting star. The shooting star is a small real body characterized by a long upper shadow, which gaps away from the prior real body.

The Shooting Star simply tells us that the market opened near its low, then prices strongly rallied up and finally prices moved down to close near the opening price. In other words, the rally of the day was not sustained.

Bearish Shooting Star Pattern is usually not a major reversal signal as is the evening star. The color of the real body is not important. An ideal shooting star has a real body which gaps away from the prior real body. Nonetheless, this gap is not always necessary.

A confirmation on the third day is required to be sure that the uptrend has reversed. The confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day.

BEARISH HARAMI PATTERN

BEARISH HARAMI PATTERN :

Bearish Harami Pattern is a two-candlestick pattern composed of a small black real body contained within a prior relatively long white real body. “Harami” is an old Japanese word for “pregnant”. The long white candlestick is “the mother” and the small candlestick is “the baby”.

The Bearish Harami Pattern is a sign of a disparity about the market’s health. Bull market continues further confirmed by the long white real body’s vitality but then we see the small black real body which shows some uncertainty. This shows the bulls’ upward drive has weakened and now a trend reversal is possible.

It is important that the second day black candlestick has a minute real body relative to the prior candlestick and that this small body is inside the larger one. The Bearish Harami Pattern does not necessarily mean a market reversal. It rather predicts that the market may not continue with its previous uptrend. There are however some instances in which the Bearish Harami Pattern can warn of a significant trend change - especially at market tops.

A confirmation of the reversal on the third day is required to be sure that the uptrend has reversed. This confirmation may be in the form of a black candlestick, a large gap down or a lower close on the next trading day (the third day).

MOVING AVERAGE CONVERGENCE/DIVERGENCE (MACD)

MACD INTRODUCTION

Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. MACD is a centered oscillator and the guidelines for using centered oscillators apply.

MACD Formula:

The most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day Exponential Moving Averages (EMAs). Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator.

Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA, and a bearish crossover occurs when MACD moves below its 9-day EMA. The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

What Does MACD Do?

MACD measures the difference between two Exponential Moving Averages (EMAs). A positive MACD indicates that the 12-day EMA is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-day EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing, indicating a bullish period for the price plot. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating, indicating a bearish period of trading. MACD centerline crossovers occur when the faster moving average crosses the slower moving average.

MACD Bullish Signals:

MACD generates bullish signals from three main sources:

1.Positive Divergence
2.Bullish Moving Average Crossover
3.Bullish Centerline Crossover

POSITIVE DIVERGENCE:


A Positive Divergence occurs when MACD begins to advance and the security is still in a downtrend and makes a lower reaction low. MACD can either form as a series of higher lows or a second low that is higher than the previous low.

BULLISH MOVING AVERAGE CROSSOVER:
A Bullish Moving Average Crossover occurs when MACD moves above its 9 day EMA. This can be considered valid when a bullish moving avg crossover occurs after the MACD line makes its second higher low, due to many times it may give a false signals.

BULLISH CENTERLINE CROSSOVER:
A Bullish Centerline Crossover occurs when MACD moves about the zero line and into positive territory. This is a clear indication that momentum has changed from negative to positive. After a positive divergence and bullish centerline crossover, the bullish centerline crossover can act as a confirmation signal.

MACD Bearish Signals

MACD generates bearish signals from three main sources. These signals are mirror reflections of the bullish signals:

1.Negative Divergence
2.Bearish Moving Average Crossover
3.Bearish Centerline Crossover

NEGATIVE DIVERGENCE:
A Negative Divergence forms when the security advances or moves sideway, and the MACD declines. The negative divergence in MACD can take the form of either a lower high or a straight decline.

BEARISH MOVING AVERAGE CROSSOVER:
A bearish moving average crossover occurs when MACD declines below its 9 day EMA Most of the times these signal gives false signals. So moving average crossovers should be confirmed with other signals to avoid false readings.

BEARISH CENTERLINE CROSSOVER:
A Bearish Centerline crossover occurs when MACD moves below zero and into negative territory. This is a clear indication that momentum has changed from positive to negative. The centerline crossover can act as an independent signal or confirm a prior signal such as a moving average crossover or negative divergence. Once MACD crosses into negative territory, momentum, at least for the short term, has turned bearish.

MACD-HISTOGRAM
The MACD-Histogram represents the difference between the MACD and its trigger line, the 9-day EMA of MACD. The plot of this difference is presented as a histogram, making centerline crossovers and divergences easily identifiable. A centerline crossover for the MACD-Histogram is the same as a moving average crossover for MACD. If you will recall, a moving average crossover occurs when MACD moves above or below the trigger line.

If the value of MACD is larger than the value of its 9-day EMA, then the value on the MACD-Histogram will be positive. Conversely, if the value of MACD is less than its 9-day EMA, then the value on the MACD-Histogram will be negative.

Further increases or decreases in the gap between MACD and its trigger line will be reflected in the MACD-Histogram. Sharp increases in the MACD-Histogram indicate that MACD is rising faster than its 9-day EMA and bullish momentum is strengthening. Sharp declines in the MACD-Histogram indicate that MACD is falling faster than its 9-day EMA and bearish momentum is increasing.