Archive | October, 2012

INDICATORS. Oscillators (6) Relative Strength Index

31 Oct

The Relative Strength Index (RSI) is a momentum oscillator developed by J. Welles Wilder to measure the velocity and magnitude of directional price movements. This is done by comparing upward movements in closing price to downward movements in price over a selected interval. Like the DeMarker indicator the RSI is designed to help determine underlying trend strength and identify over-bought/sold trade conditions. The RSI formula provides a smoothing characteristic which helps overcome distortions seen in other momentum indicators which have been introduced by large price movements at the start of the analysis interval which can cause sudden movements in the indicator even when the current price is little changed.

Trading with the Relative Strength Index (RSI)
  The Default time span for the calculation of the RSI is 14 periods. The overbought and oversold lines are typically drawn at 70 and 30, respectively. Like the DeMarker indicator longer time spans in the calculation period will result in smaller swings in the oscillator and vice versa, therefore traders typically construct narrower overbought and oversold lines for longer time periods. Shorter period RSI’s will display more volatility, making them suitable for analyzing overbought and oversold conditions. Longer period time spans are better suited for constructing trend-lines and analyzing price patterns.
Trade Signals

When markets are ranging.

Traders should look to go long when the RSI falls below 30 and rises back above it or where there is a bullish divergence with price where the first trough is below 30. Traders should look to initiate short positions when the RSI rises above 70 and falls back below it or where there is a bearish divergence with price where the first peak is above 70. Failure swings, in overbought or oversold territory signal a weakening trend and probable reversal, they also add additional weight to other signals. A bullish failure swing occurs where a trough in oversold territory precedes a second higher trough (the high of the intervening peak must not reach overbought levels) and the subsequent up-move rises above the intervening peak. A bearish failure swing occurs where a peak in overbought territory precedes a second lower peak (the low of the intervening trough must not reach oversold levels) and the subsequent down-move falls below the intervening trough.

When markets are trending.

Traders should initiate a long position during an up-trend when the RSI falls below 40 and rises back above it and go short in a downtrend when the RSI rises above 60 and falls back below it. Buy and sell levels may be adjusted higher/lower during strong trends as signals provided by the 70/30 lines can be infrequent (typically with longer period candles) and the trend favours the direction of the trade. Traders may wish to take profit on divergences with price or exit using a trend indicator. Traders should avoid selling/buying at overbought/oversold levels in strongly trending markets as subsequent periods of sideways trading can return the oscillator to more normal levels without any material favourable movement in the direction of the trade. Strong market participation during extreme buying/selling means trending prices often continue after the overbought/oversold levels are first breached. Traders are therefore advised to wait for a loss of momentum in the move with reversals in the RSI back through the oversold/bought bounds and failure swings.

 

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INDICATORS. Oscillators (5) MACD

29 Oct

The popular MACD indicator monitors trend deviation by turning two trend-following indicators (moving averages) into a momentum oscillator through subtracting the longer moving average from the shorter moving average. This gives users insight into both the trend following and momentum characteristics of the currency being analyzed. A third moving average (MA) plotted separately on the chart (known as the signal line) smoothes the MACD line, crossovers of which with the MACD line generate buy signal

Trading with the MACD Indicator
  The MACD indicator line oscillates above and below the zero line, when the fast (12 period) EMA breaches the slow (26 period) EMA to the downside the MACD line will fall through zero to show negative readings which increase in size as the fast EMA moves further away from the slow EMA.

Where the fast EMA breaches the slow EMA to the upside positive readings will be shown which increase in size as the fast EMA accelerates further away from the slow EMA. The MACD line measures this convergence and divergence of fast and slow exponential moving averages. The signal line (an EMA which smoothes the MACD indicator line) helps indicate the direction of the change in the MACD line over time.

The MACD histogram represents the difference between the MACD line and the signal line, it is positive when the MACD line is above the signal line and negative when the MACD line is below the signal line. The MACD is useful for trading trends, but being unbounded (since the MA’s can continue to diverge) it is not very useful for identifying overbought and oversold levels and therefore should not be applied in ranging markets where it can especially prone to whipsaws. It is however, very useful for showing the increasing and slowing momentum of a movement. Perhaps the best results can be achieved by using it to point to potential changes in trends through a loss in momentum via divergences in price with the MACD indicator.

Trade Signals

Signal line crossovers – these occur where the MACD line crosses the signal line to generate buy and sell signals. As a moving average of the indicator, the signal line lags the MACD and helps identify MACD turns. Buy signals are given when the MACD turns higher and crosses the signal line, sell signals are given when the MACD turns down and crosses below the signal line. Traders should exercise due diligence with the signals especially at extremities in price. Strong moves in price can push momentums to extremes, as the price move slows crossovers often occur even though the price move may continue. Volatility can also increase the number of crossovers.

Centerline crossovers – these occur where the MACD line moves above or below zero to turn positive or negative. This occurs where the shorter period EMA moves above (bullish crossover) or below the longer (bearish crossover) period EMA. Centreline crossover trades will work well when there is a sustained trend as the MACD will remain positive during sustained up-trends and will remain negative during sustained downtrends.

Divergences – divergences occur when the MACD diverges from the price action of the underlying currency. A bullish divergence forms when a currency trades at new low while the MACD forms a higher low. The lower low in price affirms the current downtrend, but the higher low in the MACD indicates less downside momentum, which can foreshadow a trend reversal. A bearish divergence forms when a currency trades at new high while the MACD forms a lower high. The higher high in price affirms the current uptrend, but the lower high in the MACD indicates less upside momentum foreshadowing a potential trend reversal.

Is BOJ setting for a surprise once again?

29 Oct

 

The consensus is for 10T yen in fresh easing but there has been plenty of talk about 20T and other measures. In the spring, the BOJ eased more than expected and USD/JPY fell, so trading it is always a minefield.

 

The FT has an awesome chart that shows the Bank of Japan faking out analysts time and time again.

CAD/CHF

29 Oct

A falling wedge is forming on H1

 

If price penetrates upwards the falling wedge then it will confirm the head& shoulders from H4.

INDICATORS. Oscillators (4) Gator Oscillator

28 Oct

Larry Williams developed the Gator Oscillator the indicator utilizes a histogram format to indicate the convergence and divergence of three Smoothed Moving Averages (SMMAs) to generate trade signals. The indicator is most useful in markets that display strong directional price action. It is designed to capture emerging trends and also indicate to traders when the trend is nearing completion.

Median Price = (High + Low)/2

  • Jaw, (blue line), is a 13 period SMMA shifted 8 periods into the future. It is the slowest indicator.
  • Teeth, (red line), is an 8 period SMMA shifted 5 periods into the future.
  • Lips, (green line), is a 5 period SMMA shifted 3 periods into the future. It is the fastest indicator.

Top bars of histogram (Above zero) = Absolute value (Jaw – Teeth)
Bottom bars of histogram (Below zero) = – {Absolute value of (Teeth – Lips)}

N.B. By default green is used for rising bars and red for falling bars (as compared to the previous bar).

Trading using the Gator Oscillator
  To trade using the Gator oscillator we first need to examine the various states of the Gator:
  • Gator Awakens: when after sleeping one of the indicator bars is red and the other one is green (either above or below zero)
  • Gator Eats: when both bars (above and below zero) are green
  • Gator Sated: when after eating one of the bars (above or below zero) turns red
  • Gator Sleeps: when both bars (above and below zero) are red
    Example

    The Gator is interpreted on the basis that each phase of a trend has a life cycle of its own indicated by the awakening, eating, stopping, and sleeping of the Gator. During the formation stage of a trend one of the upper or lower bars will turn green (gator awakening). As the trend accelerates an increasing number of double green bars above and below zero will be observed (gator eating). As the trend nears exhaustion running out of momentum one of the previously green bars will turn red (gator sated). When both bars are red, the trend has ended and a new trend cycle is awaited (gator sleeping).

    To trade the indicator traders would typically look to initiate a position during the awakening phase, holding it through the eating phase as the trend accelerates then look to liquidate/take profit on the position when the gator is sated as the trend nears completion. As the gator oscillator is a moving average based system, traders need to mindful of the limitations of moving averages when using the indicator.

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