The zig zag indicator is a bit more serious than its name would imply. The zig zag is a very basic indicator which attempts to reduce the amount of "noise" in a trending security. The aim of the zig zag indicator is to assist traders with staying in a winning position and avoid the urge to close positions on the minor reactions, which are commonplace in the market. Users can set the percentage move that will generate a change in the zig zag signal. The default value for the zig zag is 5%. This means that any counter move less than 5% will not generate a signal on the chart. Hence a trader will be able to ignore the countless minor moves that have no affect on the primary trend.
How to trade using Zig Zag
On first glance the ig Zag appears to be the holy grail of trading, but you have to remember that the values are plotted after the price closes. So, you will want to use the indicator to monitor the health of the primary trend, and not a tool for actively trading the market.
Zig Zag Chart Example
Notice how the Zig Zag line removes the noise from the chart.
Once a week a poll is conducted by Investor's Intelligence of over 100 top investment advisors. The poll asks the advisors whether they are bullish, bearish, or neutral on the market. The survey is released every Wednesday. This relationship between bullish and bearish advisors is quantified in the bull/bear ratio. Below is the formula for the indicator:
Bull Bear Ratio
Interpreting the Bull/Bear Ratio
There is a a saying on Wall Street that in order to make money in the stock market, you must go against the crowd. Well, experts are not excused from this old adage. When the bull/bear ratio reaches extreme bullish readings, it is often an early sign that the market is due for a sell off. Conversely, if the bull/bear ratio has extreme low readings, a bounce is in order. Historically readings above 60 percent are a sign of extreme optimism and readings below 40 percent reflect extreme pessimism.
Illustrated above is a zoomed in screenshot of the Chaikin Money Flow (CMF) index from the Tradingsim platform. As you can see, the indicator is a simple curved line, which fluctuates below and above a zero level. The CMF is configurable, thereby allowing traders to customize the settings to meet their trading needs. You will also notice that the indicator produces standard chart formations (i.e. double tops, trend lines, etc.) which can also provide trade triggers.
In this article we will provide a thorough overview of the indicator and provide 2 simple trading strategies you can use test drive using the Chaikin Money Flow index.
Chaikin Money Flow Definition
The chaikin money flow was developed by Marc Chaikin and attempts to determine if a stock is under accumulation or distribution by comparing the closing price to the high-low range of the trading session. In layman's terms, if the stock closes near the high of the session with increased volume, the CMF increases in value. Conversely, if the stock closes near the low of the session with increased volume, the CMF decreases in value. The chaikin money flow indicator was developed as an expansion to the On Balance Volume indicator.
Chaikin Money Flow Formula
The chaikin money flow indicator is calculated by summing the accumulation/distribution line for "x" periods. Traders generally use 21-periods for calculating the indicator. Below is the formula for the CMF indicator:
Chaikin Money Flow Formula
Trading with the Chaikin Money Flow Indicator
Zero Line Crosses
The basic trading premise with the CMF indicator is if the indicator is above 0 this is a bullish sign, while a reading below 0 represents a bearish signal. Reading above +.25 or below -.25 indicate strong trends and positions can be added on minor corrections.
Trend Lines
Like many other indicators, traders will draw trend lines on the indicators themselves and look for both breakouts on the indicator and the price on the chart. This method is very subjective, since the trader will have to accurately identify the trend on the indicator.
Divergence
Divergence can show up in the indicator when the chaikin money flow indicator makes a higher high, while the price action makes a lower low. This implies that there is less selling pressure pushing the security lower, thus a bounce is in order.
Chaikin Money Flow Charting Example
Chaikin Money Flow Chart
Above you see the daily chart of 3M for Oct, 2007 – Feb, 2008. On the chart, we also have 50-period and a 200-period Simple Moving Averages.
Notice that in the beginning of December, 2007, the Chaikin line begins crossing below the horizontal zero level. At the same time, we see that the blue 50-period SMA switches below the red 200-period SMA.
Then at the end of December, 2008, the Chaikin Index starts providing relatively lower readings. This gives us a signal that the MMM price might start decreasing with higher intensity, which is exactly what happens next.
For 22 days, 3M’s price decreases 12.20%. 5 days later, the Chaikin Money Flow index confirms a double bottom chart pattern, which was the perfect opportunity to exit the trade.
Now that we have covered a swing trade example, let's dig into a few day trading strategies using the CMF.
Chaikin Money Flow Trading
As you probably know, the most common disadvantage of oscillators is that they are not great standalone indicators. Therefore, let’s explore additional trading indicators you can use to validate signals provided by the Chaikin Money Flow Index.
2-Minute Chart Chaikin Money Flow + 15-Period EMA Trading
This strategy can be used by short-term traders to identify higher probability entry and exit points. First, we are using a 2-minute chart in order to identify setups on a lower time frame. Secondly, we only want to enter trades based on extreme Chaikin Oscillator readings, +0.2000 or -0.2000.
At the same time, we will use the 15-period exponential moving average to confirm the trade signal. We will then stay in the trade until the price closes above or below the 15-period EMA.
Chaikin Money Flow Index 2-minute trading strategy
Above you see the 2-minute chart of Visa from Sep 15, 2015. At the bottom of the chart, you see the Chaikin Money Flow index. The blue curved line on the chart is our 15-period Exponential Moving Average.
In this example, there were two trade signals generated with this strategy – one bullish and one bearish.
In the first green circle, you see the moment when the price switches above the 15-period EMA. This is the long signal we need from our EMA. 15 minutes later, the Chaikin line increases above +0.2000, which is considered a very high reading. We get a long signal confirmation and we buy Visa at $70.08 per share. This trade lasts for almost an hour, which is pretty long for a day trade. This trade generated $0.35 cents of profit (.5%).
The next trade signal materializes after the price switches below the EMA and we receive an extreme reading of -0.2000 on the Chaikin.
For this reason, we short Visa at $70.45 per share. The black arrows on the chart show the moments where the price tests the 15-period EMA as resistance. The price action for this move wasn’t as impulsive; however, in this example a trader could have made $.10 (10 cents) per share, or .14% of profit.
Scalping with the Chaikin Index and Stochastic RSI on a 1-Minute Chart
In this strategy, the point is to hit stocks for minimum profits and then exit the trade. In most cases, trades will last no more than 10 minutes.
In order to enter a position based on this strategy, we will need a double signal combination from each of these indicators. At the same time, we will stay in each trade until we receive a trade signal from the Stochastic RSI.
In other words, it will take more effort to enter a trade versus closing one. This creates the scalping effect.
Let’s now approach an example of this trading strategy.
Chaikin Money Flow Index - Scalp Strategy
Above you see the 1-minute chart of MC Donald’s from Feb 11, 2016. The image illustrates three scalp trades based on signals from the Chaikin and the Stochastic.
We start with the first trade. The Stochastic RSI is in the oversold area. Suddenly, the Chaikin crosses the zero level, giving us a long signal. A couple of periods later, the Stochastic exits the oversold area, which gives us a buy signal; therefore a long signal is generated at 117.31 per share.
Five minutes later the stochastic enters the overbought area and its lines cross downwards. We receive an exit signal and we close our trade at 117.40 per share. This trade generated $0.09 (9 cents) per share, which is a 0.08% increase for 5 minutes.
The second trade comes when the Chaikin breaks the zero level downwards. The Stochastic RSI is already in the overbought territory. Three periods after the Chaikin signal, the Stochastic exits the overbought area, giving us a sell signal.
We short MCD at 117.48 per share. Four periods later the Stochastic enters the oversold area. 15 minutes after entering the oversold area, the stochastic begins to cross upwards, giving us our exit signal at 117.38 per share. This trade generated $0.10 (10 cents) per share, which equals to 0.09% profit in 7 minutes.
The third trade comes the next time the Chaikin line switches sides. The Chaikin indicator breaks its Zero level in a bullish direction, while the Stochastic RSI is already in the oversold area. In the next period, we see the stochastic lines breaking out of the oversold area. This gives us a buy signal and we go long with the MCD stock at 117.36 per share. The price begins a slight increase afterwards. The Stochastic RSI is increasing too, entering the overbought area. Seven minutes later the stochastic lines cross downwards exiting the overbought area. This creates an exit signal and we close our long trade with MC Donald’s at 117.39 per share. In this trade we manage to catch only a $0.03 (3 cents) price increase, which equals to 0.03% for 7 minutes.
The total outcome from this Chaikin Money Flow trading system is 0.2% from three trades. We spend only 19 minutes in total for all of these trades.
Although this doesn’t look very attractive, imagine you execute not 3 but 30 scalp trades per day with this strategy. This way you will have the opportunity to reach 10 times higher profit. This turns the minor 0.2% into a more healthy 2.00%.
The key for successfully pulling off this strategy is to keep your trading commissions low. If you have a .1% commission per trade, then this will not be a profitable proposition for you.
Also, you have to effectively manage your money. For example, if you decide to plunge on one of the trades and it goes against you, then you could be facing some serious financial problems.
Stop Loss with Chaikin Index
Now that we have covered two simple strategies, we of course need to touch upon the topic of how to stop out of trades. Please remember, that without a stop loss strategy, danger is looming around the corner.
We start with the 2-Minute Chaikin Money Flow + 15-Period EMA strategy. Since you are entering trades based on a relatively high or low Chaikin value, assisted by an EMA breakout, then your stop should be somewhere below your EMA. The image below will show you where your stops should be located when trading the 2-minute chart with Chaikin Money Flow and a 15-period EMA.
Chaikin Money Flow Index - Stop Loss Strategy
Let’s now approach the scalp trading strategy which includes the Chaikin Money Flow and the Stochastic RSI. This is a high frequency strategy. For this reason, there is a greater chance for huge unexpected moves against your trades. Furthermore, we scalp for tiny profits of less than 0.1%. Imagine a 1.00% loss on a trade with 0.1% profit potential. This is how ugly it could turn if you don’t use a stop loss when scalping.
Since you are hitting for small profits, the stop loss positioning is relatively easy to implement. Simply find the bottom, which is associated with the beginning of the price move you are attempting to trade. If you cannot associate such bottoms with the current price action, simply use the previous bottom. Have a look at the image below.
Chaikin Money Flow Index - Scalp Stop Loss Strategy
This time we have included the location of the stop loss levels. Notice that we use not only the candle bodies to position the stop, but we also conform to the wicks. In this manner, the third trade had a negative risk-to-return ratio. Therefore, you will want to avoid these sort of setups, because if one or two of these go against you a day, you can start to blow up your account.
Conclusion
The Chaikin Money Flow (CMF) determines if a stock is under accumulation or distribution.
The Chaikin formula takes into consideration the close, the low, the high, and the volumes during a certain period on the chart.
We covered three types of trade signals in this article:
- Zero Line Crosses
- Trend Breakouts
- Divergence
The Chaikin Money Flow is not a good standalone tool.
Two strategies covered in this article are:
- Trading a 2-minute chart with the CMF and 15-period EMA
- Scalping a 1-minute chart with the CMF and Stochastic RSI
Always use a stop loss when you trade with the Chaikin Money Flow.
To test this strategy out and others you maybe kicking around, please visit Tradingsim.com to see how we can help.
The positive volume index (PVI) is an indicator which tracks volume as it increases from the previous day. It was first introduced by Norman Fosback in the book Stock Market Logic. The belief behind the indicator is that as volume increases, the investment community is unified with the current direction of the market. As this indicator shows the actions of the majority, it is often used as a contrarian indicator. Many professional traders utilize the PVI to assess what the smart money is doing in the market. The assumption is that on quiet days, large institutions are active in the market.
PVI Trading Signals
The most popular signal for the positive volume index is when the index drops below its 1 year moving average. Fosback believes that when this occurs, there is a 67% probability that a bear market is fast approaching.
Postive Volume Index Formula
If the current volume is greater than the previous day, then the formula for the PVI is as follows:
The fan principle is based on the use of multiple trend lines to judge a major reversal in the market. The fan principle on first glance looks very busy on the chart, but it can provide some clarity to otherwise choppy patterns. The fan pattern or principle gets its name because it resembles a "fan". It should have a minimum of three trend lines, which contain the price movement. The origin of the trend lines should come from a significant peak or trough.
How to Construct the Fan Principle
Have you ever had a stock breakout of a trend line only to back test the line? Then after the second breakout, it back tests the second breakout line. This process will wear you out and make it tough to stick to your trading guns. This is a simple of enough concept right? Well, what the fan principle provides you is a way to assess this struggle between supply and demand and to uncover the "true breakout", so you can go counter to the primary trend. The key to a good fan pattern is that the trend lines are clean and truly contain the price pattern. Another thing to look for is that there is equal distance and our slope of angle between each line.
How to Trade the Fan Principle
Since the fan principle is comprised of three trend lines, you will want to buy the break of the third trend line. By the time the third break occurs, the fan pattern has confirmed the breakout.
Fan Principle Chart Example
Remember that the break of the third trend line is usually the indication of trend reversal.
Fan Principle Chart Example
The three Fan levels are displayed by the dotted lines on the sketch. The image shows a price decrease, which reverses through the three arcs of the Fan.
Each of these levels works as support or resistance.
See that each of these levels formed by two price tops, starting from the beginning of the downtrend.
Each top of the price action in combination with the first high creates the next fan level. When the price breaks the first fan level, it then has a correction to the same level in order to test it as a support. It works the same way with the other two fan levels.
When you discover this pattern on the chart you will have the opportunity to trade in the direction of the fan breakouts after the price breaks the third fan level.
This is the ultimate position trigger of the fan. When you see a stock going through the third level of the indicator, there is a big chance that the price continues with a further extension as shown on the sketch.
Fan Trading Strategy
Tip #1 - Confirming the Fan Chart Pattern
The fan pattern confirmation starts by identifying the three fan levels on the chart.
This starts when the first level goes through the second and then ends up with the creation of the third fan level. When you have all three fan trend lines, then you have a potential fan trading pattern.
However, this is not enough in order to confirm the pattern. The real confirmation of the fan indicator comes when the price breaks the third trend line. In this manner, any actions related to the fan trading should be taken after the price goes through the third fan trend line.
Tip #2 - Entering a Fan Pattern Trade
As you probably think, the fan trade entry comes after the price action breaks the third trend. However, the trade you take should be long or short depending on the direction of the price movement.
Long Fan Trade: The sketch we discussed above is a classical long fan trade example. The price was deceasing initially, then the price action created the first and second top above the initial bearish trend. These two tops formed the second and third trend line. Hence, a bullish break through the third fan trend would trigger a long trade.
Short Fan Trade: Now let’s say that the trend we are reviewing is bullish. The short trade entry develops when the price action breaks the third fan level downwards.
Tip #3 - Fan Trading Stop Loss
You should always protect your fan trades with a stop loss order.
The best location of your fan stop loss is below the lowest bottom of your trend – in case of a bearish trend and a bullish fan respectively. If the trend is bullish and the fan is bearish, then the right place of your stop is above the highest top of the trend.
Fan Principle - Stop Loss
You are looking at the same fan trading sketch. This time, I have included a stop loss in the image – the lowest low of the downtrend. It works the same way with a bearish fan indicator, but in the opposite direction.
Tip #4 - Profit Targets with the Fan Trading Indicator
When you trade with the fan, you should be prepared for a holding your position.
This is because the fan is used to identify major trend reversals.
You will need to carefully follow the price action and pivot point breakouts. If you see the stock breaking a crucial level on the chart in the opposite direction to your trade, then this might be the right moment to close the trade.
Trading with the Fan Indicator
Now that we discussed the parameters of the fan trading indicator, I will now show you this trend reversal tool in action.
We will enter trades after the price breaks the third fan level and we will place the stop loss below the lowest bottom (or above the highest top) of the trend. At the same time, we will stay in the trades until the price starts to move in the direction of the primary trend. Have a look at the example below, which displays a fan trading example:
Fan Indicator - Trading Strategy
Above is the 1-minute chart of American Express from March 16, 2016. The image begins with a strong bullish trend, which loses its intensity, creating weaker bottoms. We use these bottoms to build the fan on the chart which consists of the three bullish trend lines (green).
The price initially breaks its trend (the first line) creating a bottom outside of the primary trend. We use this bottom and the beginning of the overall bullish trend in order to draw the second trend on the chart.
However, after a short break of the second trend, the AXP stock breaks it downwards and creates a bottom outside. We take this bottom and the beginning of the general bullish trend in order to build the third fan level on the chart.
Now we have a complete fan indicator on our graph! The confirmation of the pattern comes when the price breaks the third trend line in bearish direction. This breakout signalizes that a major reversal of the bullish trend might be on its way. Therefore, we use the breakout to short AXP.
After we sell American Express we place a stop loss right above the highest point of the trend. The right location of the stop loss is shown with a red horizontal line on the chart.
As you see, the price enters a strong bearish trend after we short AXP. The price action produces lower tops and lower bottoms, which is an indication of a strong bearish trend.
Then suddenly the chart prints a double bottom.
The orange horizontal line on the chart is the neck line of the pattern. When the price breaks this line upwards, this is a signal that the price might increase at least the size of the double bottom formation.
Since this is a nice premise for the formation of a bullish move, it is better to abandon the trade when the price goes through the orange neck line.
The interesting thing about this trading example is that the end of the first trade generates the beginning of the second one.
Fan Indicator - long and short trading example
We are looking at the same American Express chart, but after one hour of progress. The pink lines on the chart are the three fan trend lines. Each of these lines is built by taking the beginning of the trend and each successive top.
Finally, the price action goes above the third pink trend line, which is the confirmation of the Fan trading pattern.
We use this signal to go long.
Notice that this signal comes before the confirmation of the double bottom chart pattern (blue). In this manner, we can use the confirmation of this fan (pink) as an early exit from the previous trade of the green fan.
The stop loss in this trade should be located right below the double bottom pattern. The reason for this is that the two bottoms of the pattern are the lowest points of the bearish trend.
After we go long, American Express goes on a bullish run.
The increase is relatively strong and the price creates minimal corrections on the way up.
Since our profit taking strategy is based on pure price action, we build a bullish trend line on the chart (green).
The price has four bottoms on the trend line before it starts an exponential increase. After topping out at $59.60, the price begins a bearish move, which breaks the green trend.
This is the first exit signal we get on the chart, which we can use to close our trade.
However, if this signal is not enough for you, you can wait for the price to break support. This level is marked by a black horizontal line on the chart. If you don’t use the first close on the chart, then you might want to use the second one.
Conclusion
The fan trading indicator is used to predict major reversals on the chart.
The fan indicator name comes from its structure, which resembles a blowing fan.
The fan indicator is built by placing three trends one above (below) other according to the tops (or bottoms) on the chart.
The fan indicator is present after the creation of the third trend on the chart.
The actual fan pattern confirmation comes with the breakout through the third trend.
When the third trend of the fan is broken, we get an entry signal in the direction of the breakout.
There are two types of fans:
If the trend used is bearish then the fan is bullish.
If the used trend is bullish, then the fan is bearish.
When you enter a fan trade you should always use a stop loss.
When the trend is bearish and the fan is bullish, you should place a stop below the lowest point of the bearish trend.
When the trend is bullish and the fan is bearish, the stop should be located above the highest point of the Fan.
One of the best ways to take profit when trading fans on the chart is by using price action techniques. Close your fan trade when the price breaks a trend, or a crucial support. Also, watch out for reversal chart patterns on the graph.
The advance/decline index is the total number of advancing and declining security prices in the stock market. This value is calculated in real-time and is one of the most widely used market breadth indicators. The advance/decline index can be charted for any major index, but the NYSE is the most popular as its one of the largest U.S. exchanges.
Advance/Decline Index Formula
Advance/Decline Index = (Advances - Declines) + Advance/Decline Index Value of previous period
How to Use the Advance/Decline Index Line
The advance/decline index is used to measure the breadth of the market by long-term investors. The index is not a timing indicator by itself, but can be used with other key market signals to gauge when the market is losing steam. For example, if the market continues to make new highs, but the advance/decline index is trending lower, this implies that there are fewer issues carrying the market higher. When the value of the technical indicator formula is printed on a price chart, it is known as the advance/decline line. Conversely, if the market is trending strongly in one direction and the advance/decline index confirms this movement, odds are the market will continue in the direction of the primary trend.
The ADX (Average Directional Index) is a creation from technical analysis legend J. Welles Wilder. The ADX is a lagging indicator used to assess the strength of a trend. The ADX can be used on any trading time frame to determine key turning points in the market. In addition to identifying trending markets and pivots, the ADX is also used to identify choppy markets. The ADX ranges from 0 to 100. ADX values above 40 generally imply trending markets, while readings below 20 indicate flat trading.
Trading with the ADX
If you are a breakout trader, you will want to avoid trading when the ADX technical indicator is below 40. What will often happen if you put a trade on with the ADX under 40, is the stock will tend to produce false breakouts, or even worse, trend sideways for an extended period of time.
Below is an example on a 5-minute chart of how to use the ADX as confirmation with a breakout.
ADX Breakout
Below is an example on a 5-minute chart of the choppiness that occurs when there is a flat ADX reading.
The bullish percent index (BPI) is a market breadth indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey. The bullish percent index is generally plotted on with a two-point box size. Confirming Bull Markets The bullish percent index can be used to confirm bull markets. Simply count the number of X’s in the column furthest to the right and then count the most recent column of X’s on the left after a sharp move up in the market. If the number of X’s in the column on the right are greater than the number of X’s in the left column, there is a new bull market in play.
Confirm Bear Markets
The bullish percent index can be used to confirm bear markets. Simply count the number of O’s in the column furthest to the right and then count the most recent column of O’s on the left after a sharp move down in the market. If the number of O’s in the column on the right are greater than the number of O’s in the left column, there is a new bear market in play.
Bull Market Corrections
Sharp downward moves are commonplace in a bull market. Traders can use the bullish percent index to anticipate these types of moves. If the BPI has been above 70% for sometime, and then crosses below 70%, one can expect some sort of correction in order to bring more buyers into the market.
Bear Market Corrections
Dead cat bounces occur frequently during extended bear markets. Traders can use the bullish percent index to anticipate these types of moves. If the BPI has been below 30% for sometime, and then crosses above 30%, one can expect some sort of bounce in order to bring more sellers into the market.
BPI and Moving Averages
Some traders do not like to wait for the bullish percent index to make the two-point move on the point and figure chart in order to generate a trade signal. They feel that the lag time in generating bullish and bearish calls is to long and could generate late moves. So, some sophisticated traders will plot the BPI as a line and place a 5-MA or 10-MA on the chart. These traders will sell the market if the BPI crosses below their moving average of choice, or buy when it crosses above the respective moving average. The benefit of this is that traders can receive a trade signal well before the BPI crosses above 30% or below 70%. On the flipside, if a false signal in generated, the market could continue much further in the direction of the primary trend, thus extended the trader’s losses.
Kagi charts display the price action for a security. This method was developed by the Japanese in the late 1800s. Kagi charts are similar to point and figure charts in that it is not time based, but is dependent upon the price movement of the security to print a new line on the chart.
How to Construct a Kagi Chart
Kagi charts are a combination of vertical and horizontal lines. Each vertical line represents the total price movement from low to peak before a counter move occurs. As each previous high or low is exceeded a thick black line is drawn to indicate that dominant trend is still in play. While all counter moves are indicated by a thin colored line.
Kagi Charts vs. Candlesticks
Traders that use kagi charts are looking to take a lot of "noise" out of the market. Unlike candlesticks which display the open, high, low and close for each period, the kagi chart will only print if a previous swing high or low is exceeded. So, if a stock is trending in a parabolic state, there will not be enough of a counter move to print any new lines on the kagi chart. All the trader will see in this example is one solid line.
Trading with Kagi Charts
Trading with kagi charts may sounds simple because a trader is only paying attention to the major price swings, but not each minor swing point. However, whenever a trader removes information from the chart, it can leave one in the dark. There is a delicate balance between too much information (gann lines, 10 indicators, etc.) on a chart, but It is important to see how many times a security may test a given level over a period of time. Since the kagi chart only displays the price and not time, there is no way for a trader to know the amount of "strength" at a given resistance level within a given period of time.
The most common method for trading with kagi charts is to wait for a thin line, which indicates a pullback in the security. Then place a buy order above the most recent think kagi line, representing the last swing high. This basic method allows a trend trader to stay in the direction of the primary trend.
The Price Rate of Change (ROC) displays the value of the current price relative to the price of n periods ago. The Price Rate of Change can be expressed in either points or percentages.
Price Rate of Change Formulas
To plot the ROC in terms of points use the below formula:
Current Close - Close n periods ago
To plot the ROC in terms of percentages use the below formula:
The most common period for the Price Rate of Change is 12-periods for short- term signals, while 25-periods is popular among swing traders.
Trading Signals
Traders will buy a security when the ROC crosses above the 0 line and sell when the indicator crosses below 0. The ROC can be classified as either an oscillator or momentum indicator. As the Price Rate of Change trends higher with price, this is confirmation that the trend has legs. However, if the price of the security heads higher, while the ROC trends lower, this type of divergence often precedes a market top.
Optimizing the ROC
The Percent Rate of Change will have completely different values for different stocks. The best method for trading the ROC is to look at previous peaks and troughs for the indicator. By comparing the current ROC value to recent levels, a trader will know what to expect in terms of price movement relative to the most recent trading activity.
The volume rate of change (ROC) is a technical indicator used to gauge the volatility in a security's volume. The volume rate of change is a powerful indicator when estimating a security's ability to push through key resistance. The volume ROC is calculated the exact same way as the rate of change indicator except instead of tracking the closing price it tracks volume.
Volume Rate of Change Formula
The volume ROC is calculated by dividing the volume over the last "x" periods by the volume over the last "x" periods ago. If the volume from today is lower than "x" periods ago, then the volume ROC is trending lower. Below is the formula for the volume ROC:
The volume rate of change indicator is subjective like many other technical indicators and requires an intermediate level technical analysis education. The first question you have to ask yourself is how many periods should feed the input for the indicator. The shorter the periods, the greater price fluctuations will occur for the volume ROC indicator. Assuming you have selected the correct input value for the timeframe you are trading on, you want to see the volume ROC pick up significantly as it breaks through resistance. This is a sign that you are correct in your long position and the trend should remain intact for the near term.
When it comes to day trading, strategies based on the Aroon indicator are some of the best you can apply to make quick profits in the markets. Aroon is one of the handful of technical indicators that can help you achieve consistent success with trend trading, as well as trading within a range.
If you have been day trading for a while, you have probably experienced that the price of a stock or security mostly stays within a range, where the price moves impulsively. The price trends up or down only a small percentage of the time during trading hours.
The Aroon indicator formula was developed in a way that it can anticipate when the price action of a security is changing from a range bound state to a trending state, so that you can establish a long or short position. It can also indicate when the price action of a security is likely to stop trending and start consolidating.
If you are trend trader, you can use the Aroon indicator to get into a trend early and get out when the trend is about to stop. Interestingly, if you like to trade within a range, you can also use Aroon indicator strategies to formulate a counter trend trading system!
Aroon Indicator Formula
Figure 1: Aroon Up and Aroon Down Lines
The Aroon indicator was developed by calculating two Aaroon lines on a chart that usually sits at the top or bottom of a price chart. The Aroon indicator is made up of two plots on the chart, 1) the Aroon Up and 2) Aroon Down.
The formula to calculate the Aroon Up line is: [(number of periods) - (number of periods since highest high)] / (number of periods)] x 100
Conversely, the formula to calculate the Aroon Down line is: [(number of periods) - (# of periods since lowest low)] / (number of periods)] x 100
While you can set the Aroon indicator to calculate any given number of periods, most day traders use the Aroon indicator with a standard 25-periods. We would recommend that you apply the Aroon indicator strategy with the standard 25-periods as well, because it will help you stay “in sync” with the other traders in the market.
Interpreting the Aroon Indicator
As you can see in the chart above, the Aroon indicator oscillates between a maximum value of 100 and a minimum value of 0. Basically, you can analyze the relationship between Aroon Up and Aroon Down lines to interpret the price action of a stock in three different ways:
When the momentum in the market changes from a bullish one to a bearish one, and vice-versa, the Aroon Up or Down will cross over each other and change sides.
When the market is trending with strong momentum the Aroon indicator will display extreme readings.
Lastly, when the market is consolidating, the Aroon Up and Aroon Down lines will stay parallel to each other.
Using Aroon Crossovers to Determine the Direction of the Trend
Figure 2: Aroon Up and Aroon Down Crossover
You can use the crossover of the Aroon Up and Aroon Down lines in order to easily determine the directional movement of price. When the Aroon Up crosses above the Aroon Down, it generates a signal that the price is about to start a potential bullish move. By contrast, when the Aroon Down crosses below the Aroon Up line, it indicates a potential bearish move.
However, you should not place a buy or sell order whenever there is a new crossover, because this is an indication that the existing trend has changed. Instead, you should wait for the price of the security to breakout of a range or trend line before opening a new position in the direction that the Aroon suggested.
Interpreting Aroon Indicator with Extreme Readings
Like most oscillators, you can interpret the Aroon indicator readings based on where the Aroon lines are on the chart compared to the value of the corresponding levels it represents.
The key levels you need to watch on the Aroon indicator are 80 and 20. Would you like to know how to tell if the price is trending up? You just have to wait for the Aroon Up line to move above the level 80. If you find the Aroon Down line is saying below Level 20 at the same time, it would confirm the bullish trend in the market. If you find the Aroon indicator in this situation, you should definitely look to place a buy order based on your trading system rules.
In contrast, if you are about to place a short order with the stock, because you think the price has broken an important support level, you can use to Aroon indicator to confirm the bearish momentum in the market as well. As you can imagine by now, in order to confirm a bearish trend, the Aroon Down line needs to be below the level 20, and the Aroon Up line should go the opposite way, above level 80.
Figure 3: Aroon Up Showing Extreme Reading (100)
However, when you find that the Aroon Up or Aroon Down lines have reached level 100, you should always keep an eye on the market and try to protect your profits by moving the stop loss closer to the price. This is because the Aroon lines at level 100 indicates that the market has been trending for too long and might be overbought or oversold, and the price may start a counter move very soon.
In a strong trend, you should not get out of the market altogether, because any small correction in price would actually offer you another opportunity to add to your position.
For example, if the Aroon Up touches the level 100 then falls to level 90, but it is still above the Aroon Down line, you are in for a treat! It indicates a retracement in the market, and you should add to your long position instead of getting out of the market. Of course, during a downturn you should do the opposite and try to add to your short position.
Interpreting Aroon Indicator with Parallel Up and Down Lines
Figure 4: Aroon Up and Down Lines are Parallel to Each Other Indicates Price Consolidation
The interesting aspects of using the Aroon indicator in day trading is that you can also use it during range bound markets. When the price of a security consolidates within a range, the Aroon Up and Aroon Down lines will stay parallel to each other.
If you are a range trader, who likes to short the market near the top of the range and go long near the bottom of the range, the Aroon indicator can help you identify price consolidation zones and take advantage of your range trading strategy.
You know what? We will tell you a little secret. If you find the Aroon Up and Aroon Down lines to be parallel, it actually indicates that there is likely to be a breakout soon.
So, you should always pay extra attention to price action near the top and bottom of the range when the Aroon lines are parallel, as it can break out any time and start to gain momentum in either direction. So, be careful.
Aroon Oscillator
Besides the Aroon indicator, many technical charting packages also offer an additional tool called the Aroon Oscillator. If you deduct the value of Aroon-Up and Aroon-Down, you will end up getting the Aroon Oscillator value.
For example, if the Aroon Up value is currently 100, and Aroon Down value is 25, the Aroon Oscillator value would be (100 – 25) 75. You would often find the Aroon Oscillator plotted below below the Aroon Indicator using using a separate histogram in order to show the strength of the trend in question.
Aroon Indicator vs ADX
If you have been trading for some time, you can easily figure out that the Aroon indicator behaves almost exactly the same way as the Average Directional Index (ADX) indicator. However, you should remember that there are key differences between these two indicators.
If you analyze the formula of these two indicators, you would find out that the Aroon indicator uses only one major parameter, the time periods.The Aroon Up and Aroon Down lines are the amount percentage of time between the start of a time period and the point where the highest and lowest price during that period reached, respectively. In English, it means the Aroon Up and Down lines can indicate the trend strength and the direction of the trend.
On the other hand, the ADX can only measure the strength of the trend, it does not provide the direction of the trend. For that, you will need the Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI), which makes up the whole ADX system.
Moreover, the ADX uses a more complicated formula and Average True Range (ATR) to “smooth out” the chart, which has a built-in lag. The Aroon Oscillator reacts faster to changing price action compared to the ADX, as there are no smoothing or weighted factors in the formula.
Conclusion
The Aroon indicator is a nifty little tool that you should keep in your day trading arsenal. It is a visual representation of the price action that you can easily interpret to make your decision about the direction and momentum of the price. However, you can dramatically increase the odds of making a profitable trade if you implement a trading strategy around the Aroon indicator by combining it with a breakout strategy or any other price action based strategies.
The commodity channel index (CCI) is an oscillator used to identify cyclical trends in a security. It gained its name because it was originally used to analyze commodities. While the CCI will oscillate above and below the zero line, it is more of a momentum indicator, because there is no upward or downward limit on its value. The default period for the CCI indicator is 14 periods, just as the slow stochastics and RSI. Remember, if you choose to use a shorter setting, the number of signals and sensitivity of the indicator will increase.
How to trade using The Commodity Channel Index (CCI)
Traders have now begun to not only use the CCI to trade commodities, but also for stocks as well. A rule of thumb for the commodity channel index is that oversold is - 100 and overbought +100. While traders will look for divergences in the CCI and the price trend, trend line breaks of the CCI is also very popular. The real story about the CCI is not the indicator, but the community that has been developed around the indicator. An independent trader Ken Wood, has created the "CCI University" that teaches detailed methods on how to trade profitably with the CCI.
How to Use the CCI Indicator when Day Trading
Since you now know the basics of the commodity channel index, I want to explore how to use this powerful indicator when day trading.
First of all, you should remember that the CCI indicator is not a good standalone tool. Like any other oscillator, the CCI needs to be combined with an additional trading tool.
In this article, we will combine the CCI indicator with the stochastic RSI.
The first strategy we will cover is a scalping method that will allow you to hit and run for small profits on a 5-minute chart.
CCI Indicator and SRSI
The upper indicator is the commodity channel index and the lower indicator is the stochastic RSI.
Here are the rules of this strategy:
CCI + SRSI Trade Entry
To open a trade based on the CCI + SRSI trading strategy, you will need to receive two matching signals from both indicators. These could be overbought/oversold signals, divergences, or trend breakouts.
Whenever you get a signal in the same direction from each of the indicators you should follow the direction of the respective signal (short or long).
CCI + SRSI Stop Loss
The stop loss rules of our scalp commodity channel index strategy are pretty straightforward.
You can simply use price action techniques to determine the proper location of your stop.
For example, if you are buying, you should look for a bottom located near your entry point. Simply place your stop loss below this point.
On the other hand, if you are shorting the stock, you should look for a top near your entry price. You will then use this high for your protective stop loss.
CCI + SRSI Profit Target
The rules for taking profits with this strategy are even simpler than the stop loss rules.
You should close your trades whenever the CCI or the SRSI gives you a signal in the opposite direction. It may be an ordinary overbought/oversold signal, or it can also be a divergence or a trend breakout on one of the indicators.
Now let’s review these three rules in the below chart:
CCI and SRSI Simple Trading Rules
The first two green circles on the image above show the two matching signals from the CCI and the SRSI.
After the CCI line goes in the overbought area, it then breaks downwards creating the first signal.
At the same time, the lines of the stochastic RSI are also in the overbought area. The second signal comes when the two SRSI lines cross downwards as well.
This is a short signal and we sell the security.
We then place our stop loss order right above the most recent top. This is highlighted with the red line on the image.
The take profit signal comes when one of the indicators give us an opposite signal. This happens when the CCI line enters the oversold area, which is shown by the rightmost green circle.
Commodity Channel Index Trading Strategy
Now we will apply all the rules we discussed above into a complete trading strategy. We will add the CCI and the stochastic RSI on our chart as described in the strategy.
Commodity Channel Index Trading Example
Above is the 5-minute chart of Twitter from June 6, 2016.
The chart depicts five trades based on signals from the CCI and SRSI. The green circles on the two indicators show when each were aligned and we opened a trade.
The red horizontal lines on the chart show where we placed our stop loss orders for each trade.
Now that we have established the ground rules, let’s walk through the five trade examples:
On the first trade, the price reverses creating a relatively big bearish candle. In this exact moment, the lines of the stochastic RSI perform a bearish crossover and exit the overbought area. The CCI also exits the overbought area. Therefore, we have matching signals with the two indicators and we short Twitter. Our stop loss is located above the upper candlewick which creates the previous top.
Observe that the price starts decreasing. The CCI even creates a bearish trend line (blue).
Suddenly, the CCI has a slight interruption of the -100.000 area creating an exit signal. At the same time, the SRSI also has a bullish crossover in the oversold area. We need only one signal to exit the trade. However, we get two exit signals at the same time, which simply means “Get out!”, therefore we exit the trade.
But now we have two bullish signals from the CCI and the SRSI, right? Furthermore, the CCI breaks its blue bearish trend upwards, putting an extra emphasize on the bullish idea. Therefore, we buy Twitter and place a stop loss order below the bottom as shown on the image.
The price starts increasing afterwards and breaks its previous top. The two indicators are increasing too and they both enter the overbought area. However, the bearish signal comes from the SRSI, which lines cross downwards.
Then the two indicators exit the overbought area, creating a new short signal on the chart. Therefore, we sell Twitter and place a stop loss order above the top.
The price starts a bearish run afterwards and the two indicators begin dropping. On the way down, the CCI creates a bearish trend line. See that the price breaks the trend in the second green circle on the line. This is the exit signal from our trade and we close the deal.
Now we have the breakout through the CCI trend as a first bullish signal. Therefore, we are waiting for a signal from the SRSI. It comes when the SRSI enters the oversold area and its lines cross upwards. Meanwhile, the CCI line returns to its already broken bearish trend, it tests it as a support and bounces upwards. This gives additional strength to the bullish CCI signal. Now we go long Twitter and we place a stop loss below the small bearish hammer candle on the chart.
The price starts increasing afterwards. Although the indicators turn out to be pretty chaotic during this trade, they manage to inch higher. The CCI then breaks the 100.000 level upwards, creating our exit signal.
30 minutes later, the CCI exits the overbought area creating a short signal. At the same time, the stochastic RSI’s lines cross downwards and also exit the overbought area. This is the second short signal on the chart. Therefore, we sell Twitter and we place a stop above the top as shown with the last red line on the image.
The price then decreases rapidly and the two indicators follow the same example. Here we get the exit signal only 20 minutes after we enter the trade. The CCI indicator breaks the -100.000 level and enters the oversold area and we close the trade.
The five scalp trades with Twitter generated a profit of about 2% of the invested capital. At the same time, the longest trade took 1 hour and the shortest one took 20 minutes. This is why this trading strategy falls in the category of scalping.
For some of you, 20 minutes is far from scalping, but the key point is the small gains and not necessarily the length of time in each trade.
Let’s now go through another trading example of the SRSI and the CCI indicator settings.
Commodity Channel Index Trading Example 2
We now have the 2-minute chart of AT&T from June 27, 2016. The image illustrates three trading examples based on the CCI indicator trading strategy in combination with the stochastic RSI.
The first trade appears when the CCI line breaks the overbought area downwards. At the same time, the lines of the stochastic RSI cross downwards in the overbought area. This gives us the second signal we need in order to short AT&T. Therefore, we sell the stock and we place a stop loss above the top created after the decrease as shown on the image.
As you see, the price decreases afterwards. We stay in the trade until the CCI indicator enters the oversold area. This is an exit signal according to our trading strategy and we need to close the short trade.
The second trade comes when the lines of the SRSI indicator cross upwards in the oversold area and one period later the CCI line breaks out of the oversold area. We have matching signals from the two indicators, which gives us a reason to buy AT&T. Therefore, we go long and we place a stop loss order below the bottom created as shown on the image.
This is an interesting trade because both indicators give controversial signals. As you see, after we enter the long trade, the stock starts increasing. The jump lasts four periods and then the price begins to drop, as well as the two indicators. They even go back in the oversold area; however, we keep our trade open. After all, in order to close the trade, we need to see one of the indicators going into the overbought area, or to see the price hitting our stop loss order.
Although the price decreases, it doesn’t reach the level of our stop. The price then resumes its bullish move. The increase breaks the previous stop created and at the same time the indicators increase. We close the trade with a profit when the CCI line goes into the overbought area.
5 periods after we close the second trade, the CCI line breaks the overbought area downwards. At the exact same moment, the stochastic RSI lines crosses downwards. This means we get necessary signals to short AT&T. After we sell AT&T, the price instantly starts decreasing. Less than 20 minutes later the stochastic RSI goes into the oversold area and its lines cross upwards. This gives us an exit signal for our trade and we close the position.
In these three trades, we generated a profit equal to about 1.00% with our CCI scalp trading strategy. The first and the third trade took about 20 minutes each. The second trade took about 40 minutes.
Conclusion
The commodity channel index is an oscillator used to identify cyclical trends.
The CCI indicator consists of a line which fluctuates above and below a zero line.
The indicator creates overbought/oversold signals. However, it is also used to draw trend lines and to discover divergence.
The commodity channel indicator is not a good standalone tool.
A good instrument to combine the CCI with is the stochastic RSI.
The CCI and the SRSI are good for scalping the market. To implement this CCI trading strategy, you should implement the following rules:
Enter trades when you discover matching signals from the two indicators.
Place a stop loss below/above the tops/bottoms as a result of the change in price direction.
Stay in the trade until one of the indicators gives you an opposite signal.
The projection oscillator was developed by Dr. Mel Widner and is intended as a modification of the projection bands. The thing that makes the projection oscillator unique is that it measures the value of the current price to the lower and upper projection bands. Whereas other oscillators such as the stochastic oscillator only compare the current price to its minimum and maximum prices over a recent time period.
What are the Maximum and Minimum Values of the Projection Oscillator
The maximum value for the projection oscillator is 100. This means that the price is currently touching the upper band. If the indicator is at 50, it means the price is in the middle of the upper and lower projection bands. Lastly a value of 0, means the price is testing the lower projection band.
How to Trade with the Projection Oscillator
Overbought/Oversold
The easiest method for trading the projection oscillator is to buy and sell a security when the projection oscillator reaches extreme levels. So, if the oscillator crosses below 30, a sell signal is generated. Conversely, a move above 70 will generate a buy signal. This method of trading the oscillator is the least reliable as it does not take into account the momentum of the stock or current market conditions.
Crossovers
When the projections oscillator crosses a trade trigger at a specific level, a buy or sell signal is triggered. An example of a buy condition would be when the price oscillator crosses the 5-day moving average below the 30 level. Placing a moving average overlay on the indicator is a common option for many trading applications.
Divergences
Lastly, one of the most common methods of trading many indicators is to look for divergences between price action and the direction of the indicator. So, if a trader sees the stock making a new high, while the projection oscillator is trending lower, a sell signal could be triggered.
Tick volume is measuring every trade whether up or down and the volume that accompanies those trades for a given time period. If you are a day trader or a short term swing trader, tick volume analysis will assist you in sizing up the market on an intraday basis. Some traders also refer to tick volume as on-balance volume.
When analyzing the market at large, traders often focus on pivot points to look for changes or continuation in trends. This is where all the money is made and lost. In order to trade this effectively a trader will want to obtain an edge that will assist them in determining whether a pivot has the strength to hold the current trend. While many traders have access to volume on a chart, the one thing that volume charts do not show you is the volume that takes place at a given price. Would you want to buy a break of the last swing point, if you knew that it was broken on high volume? Well maybe you would, but it does not hurt to know what is going on at this critical level. Tick volume provides traders with this detailed breakdown of the trading activity at a given level. Tick volume is critical for futures traders, because it is used to assess pivot points, since tick volume is not available for the futures markets.
How to Trade Using Tick Volume
Identify a pivot point
Analyze tick volume of pivot point
Compare volume on retest of pivot point
Analyze price action on retest of pivot point
Initiate trade based on price and tick volume at pivot point
If you have been day trading with price action and volume - two of our favorite tools - then the Money Flow Index (MFI) indicator would not feel alien to you. Once you move pass the fancy name, the money flow technical indicator essentially acts as a momentum oscillator that calculates the volume and price data in order to measure buying and selling pressure.
By calculating the indexed value based on the stock price and volume of the number of bars specified in the money flow index settings, it plots a line on the chart that oscillates between the 0 and 100 level.
Figure 1: Money Flow Index of CTRP Fluctuating Between the 0 and 100 Levels
When a stock’s price rises, the money flow index also rises and is a sign of increased buying pressure. Conversely, if the stock price drops, the Money Flow Index will also decline and is a sign of selling pressure. Therefore, you can easily predict the directional momentum in the market by keeping an eye on the money flow index.
How to Calculate the Money Flow Index?
Although you do not need to calculate the Money Flow Index by hand to effectively use this indicator for day trading, it is always a good idea to fully understand the formula of an indicator prior to applying it in live trading.
In order to calculate the Money Flow Index, you need to go through four steps.
Step # 1: You Need to Calculate the Typical Price of the Stock
You can calculate the typical price of any time frame by calculating the average of the high, low and the closing price.
Therefore, the formula for calculating the typical price of the stock would be:
High of the Bar + Low of the Bar + Closing Price of the Bar ÷ 3
Step # 2: You Need to Calculate the Money Flow
You can easily calculate the money flow by multiplying the typical price of a time frame by the volume of the stock during that time frame. Therefore, if you are calculating the money flow of a daily bar, all you need to do is multiply the typical price found in step # 1 by the daily volume. Similarly, if you are calculating the money flow of a 5-minute bar when day trading, you simply take the price of the 5-minute bar and multiply it by the volume generated within that time frame. Simple!
Money Flow = Typical Price x Volume
In order to plug the money flow into the Money Flow Index formula later on, you also need to find the positive and negative money flow. The rule of thumb is:
If you add all the money flow from the time frames where the typical price was higher compared to the previous bar, then you would end up with a positive money flow
If you add all the money flow from the time frames where the typical price was lower compared to the previous bar, then you would end up with a negative money flow
So, if you have 14 periods in the Money Flow settings, you need to look for bars that have a price higher than the previous bar to find positive money flow. On the other hand, to find the negative money flow, you need to look for all the bars that had a typical price lower than the previous bar.
You might be wondering what should you do if the typical price remains the same compared to the previous bar? Well, just ignore that bar and move on!
If you have any confusion regarding this step, feel free to leave us a comment below and we would be happy to help you answer any questions.
Step # 3: You Need to Calculate the Money Ratio
You can calculate the money ratio with another simple formula:
Money Ratio = Positive Money Flow ÷ Negative Money Flow
By now, you should be able to guess that if the money ratio exceeds 1, the stock has a bullish sentiment, right? If you understand everything up to # 3, you have pretty much figured out how the Money Flow Index works. But, there is one last step!
Step # 4: You Need to Calculate the Money Flow Index (Finally!)
The last calculation you need to perform would lead you to the actual Money Flow Index. The formula for the Money Flow Index is the following:
Money Flow Index = 100 – (100 ÷ (1 + Money Ratio)
As you can see, the Money Flow Index essentially shows the percentage of positive money flow compared to the total money flow.
How Can You Apply the Money Flow Index Indicator in Trading?
If you have traded the Relative Strength Indicator (RSI), then you would not have much trouble incorporating the Money Flow Index into your day trading. This is because the Money Flow Index indicator also fluctuates between 0 and 100, as discussed above.
Now, if you find the Money Flow Index reading is above 80, you should be very cautious about the uptrend as anything around level 80 indicates an overbought market condition where the price may start a short-term counter move or retracement.
By contrast, when you find the Money Flow Index reading below 20, you should start to reduce your short exposure as it indicates the stock is oversold and the price will likely increase.
Since the Money Flow Index is a momentum oscillator, you use this to confirm the price action. If the Money Flow Index is declining and your trading system generates a sell signal, the odds of the stock price going down would be much higher. Similarly, you can utilize the Money Flow Index indicator for taking a long position when the money flow index chart is going up.
There is another way you can use the Money Flow Index indicator, and that is as a divergence signal. If you find that the stock price is going up, but the Money Flow Index is declining, it would provide insight that the uptrend is weak and should not be trusted. A divergence like this indicates that the stock price would likely start a correction phase. You can apply the same divergence strategy when the price is falling, but the Money Flow Index is rising.
Money Flow Index Example Trade # 1: Buying an Oversold Stock
Figure 2: Money Flow Index Is Showing Oversold MSFT
In figure 2, you can see that the MSFT price is oversold and indicating a potential retracement. All of a sudden, a bullish price action bar (pin bar) appears on the 5-minute chart and the MSFT price begins to increase. If you had the Money Flow Index on your chart, you would have been already anticipating a retracement and by combining price action, you could have easily placed a BUY order with confidence.
Money Flow Index Example Trade # 2: Selling an Overbought Stock
Figure 3: Money Flow Index Is Showing Overbought RDUS
In figure 3, you can see that the RDUS price had a huge gap and the Money Flow Index reading was above 80. If you have read this article from the beginning and understand how to use the Money Flow Index in trading, you should be able to identify that this is a great opportunity to sell the stock, right?
Money Flow Index Example Trade # 3: Spotting a Money Flow Index Divergence
Figure 4: Money Flow Index Showing Divergence
As we discussed earlier, Money Flow Index can be a great tool to identify divergence in the market. In the same RDUS chart, you can see that the stock was showing a bearish divergence after the Money Flow Index reading went above 80. As a result, the RDUS price soon not only started a retracement, the uptrend actually turned into a downtrend.
Conclusion
If you are familiar with the Relative Strength Indicator Formula, you might have realized by now that the Money Flow Index simply incorporates the ratio of positive and negative money flow into the RSI. This is why some professional traders refer to the Money Flow Index indicator as the Volume-Weighted RSI.
Since the Money Flow Index incorporates not only price, but also volume, it is often really good at picking tops and bottoms in the market.
Volatility is your friend when trading the market. It is like dark matter in the universe; you can't see it, but it's the very essence of the market. There are a number of volatility indicators, one of which we will cover in this article. Volatility is such a unique attribute, how do you know when it's considered just right or a little over the top? To ignore volatility could be one of the most costly errors in your trading career. In this article we will decompose volatility and provide you a simple, yet effective way to start tracking this tool when trading.
Best Volatility Indicator
There are a number of volatility indicators in the marketplace. None of which I plan on covering in this article. If you have been reading the Tradingsim blog you will quickly notice as you scan through the articles that I like to keep things simple. To that aim, we are only going to focus on one volatility indicator and that is the average true range (ATR). For those that have never heard of the average true range, it basically tracks the range of price movement in a security. In Lehman's terms it looks at the spread between the high and low points of each day or time interval over "x" period of time. If the stock begins to swing wildly, then the average true range will increase in value. Conversely when things get a little choppy or quiet, the average true range will fall in value. The great thing about the average true range is it doesn't provide oversold or overbought values. So, all of you people looking to get out of doing your own homework and analyzing the stock, I feel sorry for you.
Manipulating the Average True Range Indicator
There are probably a dozen or more indicators that provide what I am going to show you, but for my simplistic folks out there you will appreciate what I am getting ready to present. To perform this exercise you will need three things: (1) a chart, (2) average true range indicator and (3) a calculator. One thing you will notice is that the average true range can have any value because its based on the range of the stock. You could look at Apple and see an ATR value of 15 and then switch over to ZNGA and see a value of 2. On face value you really have no way of knowing which stock is more volatile than the other. You can look at the average true range values over the last number of bars to try and identify some sort of anomaly. Only problem with this approach is if you are scanning the market and looking through hundreds of charts, who has the time to perform not only a deep dive analysis of the chart, but also of each stock's ATR? We need a quick way to analyze the volatility in order to make quick decisions.
If your charting application has the ATR indicator I want you to perform a very simple function. Take the ATR and divide it by the closing price of the stock. So, if the stock closed at $30 dollars and the ATR is at 3, then you would get a value of .1 (3/30). The higher this value the greater the volatility in the stock. Now what you need to do is look through your specific time frame (i.e. 1-min, 5-min, 15-min). Identify stocks that have the sort of volatility you are comfortable with and start to think of which manipulated ATR works best for your trading style. You will notice a "comfort" range will start to develop.
Let's make this tangible, because I feel like I'm losing you. I like to trade breakouts in the morning and I need to make a minimum of 1.6% on every trade I take. So, if I buy a stock that trades tightly I am basically walking into that trade where the odds are against me making my profit target. This is where so many traders go wrong. If you do not read anything else in this article, please understand this basic principle, the volatility of the stock you are trading must be in direct alignment with your profit targets. If you can master this principle you will have control of the "dark" matter present in the market.
Profits and Volatility
Let's look at a real-life example of how we would apply this technique. Trader Susan is what what I like to describe as a real risk taker in the market. It does not phase her if a stock moves wildly in a matter of minutes. To Susan this is putting some skin in the game. As she scans the market Susan comes upon two charts. The one on the left is Radio Shack and the chart on the right is IBM.
Which of the two charts do you think Susan would want to trade? If you are honest with yourself the chart on the right appears to have wilder swings in it's ATR. Well this would happen to be IBM. Now, upon further review when we perform our simple ATR calculation we get the following:
RSH: .04/3.82 = .010
IBM: .63/210.28= .003
Now what does this mean. Well this is telling you that in a head-to-head competition RSH is 3 times more volatile than IBM. Could you see that just looking at the candlesticks? Of course not. Depending on your zoom and the respective time frame, a stock can give the perception of being a mover. Well why did IBMs ATR appear to have a greater swing. The range on IBM is in dollars, while RSH is in pennies. Naturally the swings in the ATR will appear much larger for IBM and give the illusion the stock has far greater volatility.
Stereotyping your ATR
In the modern day world we are very reluctant to place people and sometimes even things into buckets. Well, when it comes to classifying your stocks, you need to be pretty judgmental. First, you will want to determine what type of trade you are looking to place in terms of your appetite for volatility. This could be the same all day, everyday or your risk profile could change depending on the market. You will want to place yourself into 1 of 3 buckets: (1) low key, (2) middle of the road, and (3) looking for some action. Now since every time frame will present different values for the manipulated ATR and each trader will need to define what volatility means for their system, there are no predefined values. Sorry, you have to do a little work. Let me give you an example of how this is done so you have a blueprint.
I am a 5-minute trader; this is my permanent zip code. I also like to stay on the wild side of the "middle of the road" but not quite in the "looking for some action" crowd. After scanning the market I have noticed the following ranges for me on my 5-minute charts:
(1) Low Key = .001 > .005
(2) Middle of the Road = .005 > .01
(3) Looking for some action = >.01
Again, this is on the 5-minute chart, so my manipulated ATR values are going to be much smaller because the high/low range on the candlestick is smaller the lower the time frame you trade. If for example you were to use a 60-minute bar the starting ATR value would be much larger than a 5-minute candlestick and therefore your manipulated ATR value be considerably larger.
In Summary
You can only ask of the market what she can bear. As a new trader I would put on positions and then get restless when things did not happen as smoothly as I was expecting. This was because what I thought would happen in 20 minutes hadn't happened during the day for the stock in over 3 weeks. So, why would things change that I am in the trade? It's not enough to identify a good setup, place your stops and follow all of your rules to the letter. You and the market have to be sync in terms of what you expect from each other.
Try placing the last 50 or so of your day trades into the three buckets. Watch how you will notice that on a good number of your losing trades or not so great trades, you were just asking too much from the market.
The average true range (ATR) is a great tool for determining the level of volatility across stocks to align your investment choices with your risk profile.
The ATR should not be used to identify stop loss and exit targets as past volatility is not a predictor for future activity. This average true range trading strategy has a number of flaws, which are identified in this article.
What is the average true range indicator?
The average true range indicator is an oscillator, meaning the ATR will oscillate between peaks and valleys. The ATR has no upper or lower limit bounds like the RSI or slow stochastics. The other unique characteristic of the ATR is the value of the indicator is based on the price performance of the stock in question. Therefore, Apple may have an ATR of 15, while Baidu may have an ATR of 38. This lack of consistency makes the ATR a favorite in my trading toolkit, because it requires the technical analyst to assess the stock's volatility on a case-by-case basis and not make general assumptions about a stock's performance.
Average true range formula
Let us quickly cover the average true range formula, so we can focus on how to use the ATR.
The ATR formula is comprised of three key inputs, which is why the word "true" is in the title, because these three inputs provide a more holistic view of a stock's trading activity.
How to Calculate the Average True Range
The average true range is comprised of three inputs, which are helping identify the volatility of a security. To determine the level of volatility there are three ranges included in the equation
Input 1 - Current Day's Range
Current High - Current Low
$75 - $70= $5
Input 2 - How High has the security risen from the previous day's close
Absolute Value (Current High - Previous Close)
($75 - $80) = 5
Input 3 - How low has the security dropped from the previous day's close
Absolute Value (Current Low - Previous Close)
($70 - $80) = 10
The highest value of the three inputs is the ATR, so in the above example 10 is the ATR for this point in time.
In order to calculate the average true range, you take the average of each true range value over a fixed period of time. For example, when calculating the average true range for a 14-day period you would take the average of the true ranges over 14-days.
For more information on average true range calculators, excel formulas and history, below are a list of great sources:
Average True Range Excel Example - Invest Excel (You will need to scroll down near the bottom of the article to locate the download spreadsheet link)
To uncover the history and origins of the Average True Range you will want to read the book by the ATR creator, J.Welles Wilder - titled 'New Concepts in Technical Analysis'.
Average True Range Chart
Average True Range of Apple on a 5-minute chart
The average true range is an off-chart indicator, meaning you will plot the indicator above or below the price chart. For me, I prefer to have the average true range below both the price chart and volume indicator.
As you can see from the above chart example of Apple, the average true range moves lockstep with the price action as the stock moves from highs to lows. The one key differential for the average true range is that the indicator will experience extreme highs and lows based on the volatility independent of price direction. Remember, the ATR is based on the absolute value, so you can have a high ATR value as a stock is plummeting.
How to Use the Average True Range Indicator
The average true range indicator is a volatility measure of a stock's performance. Below are the key ways traders use the indicator:
One of the greatest challenges for new traders is avoiding drawdowns on their account. Drawdowns are what kills a trader's ability to consistently earn over the long haul and creates enormous emotional pain and turmoil.
Drawdowns are a result of two factors: (1) over leverage and (2) extremely volatile stocks. One could argue that if you get number 1 right, the volatility is irrelevant; however, these two elements are not always mutually exclusive.
Early on in my trading career I would have the standard rule of I only want to use "x" amount of dollars or risk "x" amount of dollars per trade. The challenge I would face after entering the position is that the stock would move wildly in one direction or another in ways that I either did not anticipate or were not accustomed.
I quickly realized that I needed a common method for not only identifying great setups, but also a way to rate a stock's volatility.
To this aim, I began researching the average true range indicator.
The problem I had with the ATR is that the indicator's value was different for each stock. Higher priced stocks had higher ATRs versus the low priced momentum players.
In order to find a universal method for assessing the risk, I divided the ATR by the stock price to establish a ratio of the range relative to the stock's price. Using the above chart example, take the 14-period ATR divided by the closing price of Apple on the 5-minute chart (.42/$126.39) = .0033.
On the surface, this .0033 means absolutely nothing. Now, let us apply the same math to a more volatile stock.
ATR XOMA Chart
XOMA has a stock price of $3.15 with an ATR of .04 which gives us a volatility ratio of (.04/$3.15) = .0126. .0126 is 3.84 times greater than .0033, which is the volatility ratio for Apple on the same 5-minute time frame. Therefore, a trader would need to give XOMA more wiggle room as the stock is likely to have greater percentage moves up and down.
Now that we've mastered basic arithmetic, let's walk through how to apply this to your trading regimen.
As you begin to analyze the volatility ratio of stocks, you will begin to identify the stocks that have just the right mix of volatility for your trading appetite. Meaning, over time you will identify the right mix of volatility that gives you the returns you want with just the right amount risk.
For you, your volatility range could be .012 - .02. Alternatively, you could be more conservative and want to only trade stocks with a volatility ratio of .0025 - .0050 on a 5-minute range.
The key thing to remember when determining which volatility ratio works best for your trading style is to stick to one time frame. You cannot evaluate the 5-minute volatility ratio and then compare that to a daily volatility ratio, even if it is the same stock. The common thread is the timeframe; otherwise, you are comparing apples to oranges.
Stop Loss/Exiting a Trade
The key to making money in the market is buying a stock for less than what you want to sell the stock. This is a basic concept, but easier said than done.
When attempting to identify a great entry point, a key indicator that a stock is likely in the process of going counter to the primary trend is a drop off in volatility. In theory, this equates to diminishing price movement, which implies that either the buying or the selling interest is tapering.
So, how do we use the average true indicator as an early sign that the stock is likely going to have a change in trend, so we know where to execute a stop loss to exit a trade?
For newbie traders, this explanation will get a bit muddy, but do the best you can to stay with me.
The below chart is of Apple from the time period of late April through early May. Apple had a nice run up from $125 through $134, only to retreat down through $125.
Looking at the ATR, do you have an idea of where to place the average true range stop loss?
ATR Apple Example
In simple terms, you will apply a multiplier to the ATR value to determine your profit and stop loss values. The key of course is making sure your multiplier for the target price is greater than the stop loss, so over a series of trades you have a greater likelihood of turning a profit.
In the Apple example above you would take the ATR value of .29 and then apply for example a 3x multiplier for your target and 1x for your average true range stop. This would provide you a target price of (.29 *3) + $126.47 = $127.34. Conversely, the average true range stop loss for this trade would be $125.6.
On paper, this makes a lot of sense. For every dollar you risk, you can make up to 3 times in profits. Following this model, you could have more losing trades than winners and still be in the black.
However, as I evaluate the use of applying this average true range exit strategy, I see a number of flaws.
For starters, applying a multiplier to the average true range during a dull trading period will limit you in the potential gains as your profit targets are relative to the most recent trading volatility.
In terms of stop loss, if a stock is in a whipsaw-trading period, then you will likely be stopped out due to the tight price action.
If you could only use the ATR to determine when to get in and out of trades wouldn't life be grand? In reality, you will need additional confirmation for what the ATR is telling you and what better confirmation than price?
How to Use the Average True Range for short-term trading
Using the ATR to assess the price movement is a much better usage of the ATR. Having the ATR act as a profit target and stop loss mechanism is asking too much of the indicator.
Let's take another look at the 5-minute Apple chart when we combine both the ATR and price channels.
Price and Average True Range Spike
The same way stock prices will trade in clear trends, so can indicators such as the ATR. Notice in the intraday chart of Apple, both the ATR and stock price were in channels of sorts. The ATR was in a clear horizontal channel with low volatility, while Apple's stock price stayed in a clearly defined uptrend.
This combination of low volatility combined with a clear up trend let's you the trader know that the up move is measured and can be traded with high confidence.
Then just as the market lulls you to sleep, volatility will rear its ugly head to ruin the parade.
Again, I am not a user or believer of ATR as a standalone indicator for determining stop loss or profit targets when trading. However, one cannot deny the power of combining the ATR with price action to identify a likely change in trend.
Notice how the ATR and price both spike at the same time in the Apple chart. More importantly, notice how the price spikes right through the support line.
In every other touch point of the support line within the channel, the ATR remained in its tight horizontal trading range. As a trader, the violent break and ATR spike should have set off all types of alarms that the easy money was no longer available.
Apple managed to muster up one last push higher, before the stock had a swift sell off taking the stock back to the starting point of the preceding rally.
Someone could make the argument that of course Apple reversed; you could see how quickly the price moved down...no brainer. Well, yes and no. By having the pulse of Apple's volatility over the preceding weeks, you could see the magnitude of the move in terms of volatility that is otherwise unclear by only reviewing the price chart.
In Summary
The ATR is a powerful tool, which I use in both my day trading and swing trading activities. As you further explore the indicator, remember that the real power of the ATR is in its ability to judge the "frenzy" and the "calm" in a security.
To quickly recap, below are the key takeaways from this article:
Use the ATR to Gauge the risk of a trade prior to entering the position. If you like the slowness of IBM, you should not trade a $3 dollar biotech.
Do not use the ATR for placing stops and profit targets. Again, if you use the ATR to create a profit target right before a massive breakout, you will likely gain a fraction of the true profit potential.
To further explore the ATR, please test-drive your theories using the #1 Market Replay Tool - Tradingsim.com. In addition to the ATR, we have a host of other technical indicators and studies, which you can practice using in a stress free environment with real historical tick data to see what works best for your trading style.
Fans of the Tradingsim blog know that I am big on volume. Volume is probably one of the oldest off chart technical indicators you will find in technical analysis. So, as I'm looking through the technical indicators I have been intrigued by the possible uses of the volume oscillator indicator.
The volume oscillator displays the relative strength of a shorter volume moving average to a longer one. To keep things super simple, whenever there is a positive reading for the volume oscillator, there is strength on the short-term in the direction of the primary trend. If the volume oscillator is in the negative territory, volume is lacking and a change in trend is likely.
In this article, I will cover 4 strategies for how to trade with the volume oscillator. If you are looking for how to calculate the volume oscillator and more of a technical definition of the indicator, please visit the TA-Guru.
From a guy that believes that volume is the key to identifying the strength of a trend and where the smart money is placing their bets, the volume oscillator provides an interesting perspective for how to view market activity.
We all have seen the volume bars at the bottom of the chart which shows trading activity like the chart below:
Volume Example
As a trader, you will look for when volume is drying up and when volume is accelerating. The red and green volume bars provide us an indication of how the price closed. Nevertheless, what is the volume actually telling you about the future direction of the trend?
Depending on the trade setup and volume at previous peaks or troughs, the market could be sending you a number of signals.
Interpreting these signals is where the volume oscillator can provide clarity on where the stock could be headed.
In the following examples, I will be using 5 periods for the short-term and 10 periods for the long-term, as these are the defaults in the Tradingsim platform.
#1 - Breakout Confirmation
Breakouts have a high failure rate in the market, because these are levels, which are very visible to all traders. There isn't some mystical Fibonacci level or complicated trendline; it comes down to a break of a recent high or low. Let's take a look at a few breakout examples and the corresponding readings of the volume oscillator.
Apple Breakout
The first example is of a breakdown of Apple on a 5-minute chart. Notice how as Apple approaches the previous swing low, the volume oscillator spikes higher.
Volume Oscillator Spike
The previous swing low had a volume oscillator spike in the neighborhood of 23.42, while this break had a reading of 31.74. So, does this guarantee the price will continue lower? Absolutely, not!
The way you should interpret this is that the amount of selling pressure increased on the retest of the swing low. At this point, one of two things can happen: (1) Apple would reverse sharply as a selling spike could lead to a trend reversal or (2) Apple will continue lower as the bears are in control.
Let's fast forward in time to see how the action played out for Apple.
Apple Much Lower
Now that we have shown the happy path, let's dig into an example where the volume oscillator failed.
Volume Oscillator False Signal
On this breakout, Apple had a nice spike in the volume oscillator on the positive side, which should have resulted in a continuation of the breakout. However, as you look at the chart, you will notice that Apple actually reversed at this critical level and generated a bull trap.
How could you have known that the signal was false?
On the surface, there really wasn't anyway for you to have known that Apple was destined to reverse and head lower by simply looking at the volume oscillator in a vacuum.
Just as with any other indicator, you need to see both price and volume confirm the move. Once the price action began to creep back below the breakout level, that was your cue to exit the position.
If you get nothing else out of this section of the article, remember that you cannot trade breakouts with the volume oscillator blindly. You must have some predefined method for confirming the trend.
#2 - Riding the Trend
Volume in a strong uptrend or downtrend can be quite deceiving. The volume will appear to just float with little fan fair as the stock continues in the direction of the primary trend. This can prove challenging to interpret, because it's as if the market is floating with little purpose when in actuality the lack of push from participants should trigger a reversal.
Let's look a look at the perfect example where the volume oscillator would have kept you in a position.
volume oscillator and strong trend
First, let me say that I personally hate these types of charts, because it leads people to believe you can find these setups on a daily basis. Let me be clear, they are super rare. You are better served making consistent profits instead of looking for these 90-degree charts.
Now that I have placed the disclaimer, PBMD had a massive intraday move.
After clearing resistance at the $3 dollar level, the stock began to rally significantly all the way up to $6 dollars. Looking back at the chart, there was no reason present to sell, but let me tell you that sitting with that much of a paper profit on a day trade is one of the toughest things you can face in life.
Upon further review, you can see that the volume oscillator did a nice job of containing the trend as the oscillator never dipped below the zero line. This tells you as a trader that the short-term strength in volume was behind the move and the stock was headed to higher ground.
The likelihood of you finding a stock that hovers above its 0 line on the volume oscillator will be hard to find, but when all starts align, it's a beautiful thing.
#3 - Volume Oscillator and Choppy Markets
You figure this one out and I will give you a gold medal. The volume oscillator in my humble opinion provides a ton of false signals when the market is trading in tight ranges. The price and volume action will look non-existent, yet the oscillator could be moving above and below the 0 line. As a trader, this would really annoy me as the appearance of underlying strength or weakness is nothing more than a false signal.
Let's look at a few chart examples for clarity.
Volume Oscillator and Choppy Markets
Is it me or do the spikes in the oscillator make it appear as though there is more going on in this chart? The bottom-line is that we have no idea which way the stock will break and only time will tell whether the bears or bulls are correct.
What you can see using the volume indicator is that there is an increase in the volume when the stock finally broke support. Which is a perfect segue into the next section of this article.
#4 - Drawing Trendlines on the Volume Oscillator
Another method used to trade with the Volume Oscillator is to actually draw trendlines on the indicator. The goal here is to identify breakout patterns on the indicator to signal the stock price will also likely start trending. I'm not a big fan of this approach as it starts to clutter your chart and I feel like the breakout is just a coincidence as you are working with a large number of data points. At times the volume oscillator will breakout prior to the trend and other times it won't.
It's just the law of averages.
Below is an example of where the volume oscillator was able to break through a trendline, as price was also making a breakout on the chart.
volume oscillator trendline breakout
In the above example, Hawaiian Holdings (HN) had a breakout of the volume oscillator and then a back test of the trendline prior to breaking out. I haven't run a detailed analysis on how often this occurs, but again my gut tells me that it boils down to at some point, lines on a chart start to tell the same story. It just so happens these stories are just by chance.
Volume Oscillator versus Volume
Here is the real test. Does the volume oscillator add any additional value that isn't already present in the volume indicator?
The reason I am asking this question is because traders as a whole need to simplify their methodology.
Trading is the same way. As you begin to hone your craft, you may find yourself in a trap where you are adding more and more indicators on the chart. Call it a security blanket, insecurity or just over thinking it, your chart can begin to fill up.
So, always challenge your desire for one more indicator.
volume oscillator versus volume
In this example, we are looking at ACHC on a 5-minute timeframe. Notice how the stock shot up on high volume. After the initial breakout, ACHC consolidated for a few candles and then screamed higher again. As you can see in the volume activity, this was a huge surge as the volume was many multiples higher than the average.
Now take a look at the volume oscillator. The oscillator definitely made a strong move higher, but the oscillator failed to drastically exceed any of the recent peaks for ACHC.
Therefore, the answer to this question is because the short-term and long-term periods are 5 and 10 respectively.
If we expand the delta between the slow and fast periods, the volume spike is a bit clearer, but not by much.
While the peaks are a bit clearer, the volume oscillator doesn't come close to standing out as well as the volume indicator. Why do you think this is the case?
Simply put, as the slow and fast volume averages surge higher, they do so relative to each other. Therefore, you will never get the contrast you would find looking at each volume bar side-by-side.
Final Verdict
The volume oscillator like any other indicator can prove useful when combined with price action and trend lines. I do however, feel like in the long run, it's better to have a solid understanding of the volume indicator to ensure you can see the bigger picture and not get too lost in the spikes of the volume oscillator.
If you still want more regarding the volume oscillator, please check out this informative video posted by Jeff Bierman on YouTube.
I hope you found this article helpful and if you want to test drive the volume oscillator for yourself, feel free to visit our homepage to gain a better understanding of the Tradingsim Platform.
I don't know about you, but what was Bill Williams thinking when he came up with the name awesome oscillator?
With names floating around as complex and diverse as moving average convergence divergence and slow stochastics, I guess Bill was attempting to separate himself from the fray. To learn more about the awesome oscillator from its creator, check out Bill's book titled 'New Trading Dimenstions: How to Profit from Chaos in Stocks, Bonds, and Commodities'.
In this article, we are going to attempt to better understand why Bill felt his indicator should be considered awesome by evaluating the three most common AO trading strategies and a bonus strategy, which you will only find here at Tradingsim.
So what is the Awesome Oscillator?
Well by definition, the awesome oscillator is just that, an oscillator. Unlike the slow stochastics, which is range bound from +100 to -100, the awesome oscillator is boundless.
While on the surface one could think the awesome oscillator is comprised of a complicated algorithm developed by a whiz kid from M.I.T., you may be surprised to learn the indicator is a basic calculation of two simple moving averages. That's right folks, not an EMA or displaced moving average, but yes, a simple moving average.
Awesome Oscillator Formula
To my earlier point, if you have a basic understanding of math, you can sort out the awesome oscillator equation. The formula compares two moving averages, one short-term and one long-term. Comparing two different time periods is pretty common for a number of technical indicators, the one twist the awesome oscillator adds to the mix, is that the moving averages are calculated using the mid-point of the candlestick instead of the close.
The value of using the mid-point allows the trader to glean into the activity of the day. If there was a ton of volatility, the mid-point will be larger. If you were to use the closing price and there was a major reversal, you would have no way of capturing the volatility that occurred during the day.
The fact Bill saw the need to go with the mid-point, well is a bit awesome.
Fast Period = (Simple Moving Average (Highest Price + Lowest Price)/2, x periods)
Slow Period = (Simple Moving Average (Highest Price + Lowest Price)/2, x periods)
Awesome Oscillator = Fast Period - Slow Period
One point to clarify, while I listed x in the equation, the common values used are 5 periods for the fast and 34 periods for the slow. You however, reserve the right to use whatever periods work for you, hence the x in the above explanation.
Awesome Oscillator on the Chart
Depending on your charting platform, the awesome oscillator can appear in many different formats. Nevertheless, the most common format of the awesome oscillator is a histogram.
The awesome oscillator will fluctuate between positive and negative territory. A positive reading means the fast period is greater than the slow and conversely, a negative is when the fast is less than the slow.
The one item to point out is that the color of the bars printed represent how the awesome oscillator printed for a period. Hence, you can have a green histogram, while the awesome oscillator is below the 0 line.
Awesome Oscillator Histogram
Basic Awesome Oscillator Trading Strategies
Now that we are all grounded on the awesome oscillator, let's briefly cover the 3 most common awesome-oscillator day trading strategies.
#1 - Cross Above or Below the Zero Line
If you use this strategy by itself, you will lose money. I hate to speak in such absolutes, but to trust an indicator blindly without any other confirming analysis is the quickest way to burn through your cash.
Wow, did I just go off like that without further explanation?
I'm back. Therefore, the strategy, if you want to call it that, calls for a long position when the awesome oscillator goes from negative to positive territory. Conversely, when the awesome oscillator indicator goes from positive to negative territory, a trader should enter a short position.
Without doing a ton of research, you can only imagine the number of false readings you would receive during a choppy market.
Let's look at a chart example to see the cross of the 0 line in action.
Awesome Oscillator 0 Cross
In the above example, there were 7 signals where the awesome oscillator crossed the 0 line. Out of the 7 signals, 2 were able to capture sizable moves.
This 5-minute chart of Twitter illustrates the main issue with this strategy, which is that the market will whipsaw you around like crazy. Choppy markets plus oscillators equals fewer profits and more commissions.
For this reason, I give the cross of the 0 line an F.
#2 - Saucer Strategy
The saucer strategy received its name because it resembles that of a saucer. The setup consists of three histograms for both long and short entries.
Long Setup
Awesome Oscillator is above 0
There are two consecutive red histograms
The second red histogram is shorter than the first
The third histogram is green
Trader buys the fourth candlestick on the open
Short Setup
Awesome Oscillator is below 0
There are two consecutive green histograms
The second green histogram is shorter than the first
The third histogram is red
Trader shorts the fourth candlestick on the open
Without going into too much detail, this sounds like a basic 3 candlestick reversal pattern that continues in the direction of the primary trend.
Awesome Oscillator Saucer Strategy
In the above example, AMGN experienced a saucer setup and a long entry was executed. The stock drifted higher; however, I have noticed from glancing at a number of charts, the buy and sell saucer signals generally come after a little pop. If you trade the saucer strategy, you have to realize you are not buying the weakness, so you may get a high tick or two when day trading.
The saucer strategy is slightly better than the 0 cross, because it requires a specific formation across three histograms. Naturally, this is a tougher setup to locate on the chart.
However, you can find this pattern when day trading literally dozens of times throughout the day.
I get that we are attempting to locate a continuation in the trend after a minor breather in the direction of the primary trend, but again the setup is just too simple. It doesn't account for trend lines or the larger formation in play.
Due to the number of potential saucer signals and the lack of context to the bigger trend, I am giving the saucer strategy a D.
#3 - Twin Peaks
Now this is not the restaurant for all you chicken wing and brew fans out there.
This is a basic strategy, which looks for a double bottom in the awesome oscillator.
Bullish Twin Peaks
Awesome oscillator is below 0
There are two swing lows of the awesome oscillator and the second low is higher than the first
The histogram after the second low is green
Twin Peaks
Bearish Twin Peaks
Awesome oscillator is above 0
There are two swing highs of the awesome oscillator and the second high is lower than the first
The histogram after the second peak is red
Bearish Twin Peaks Example
As you have probably already guessed, of the three most common awesome oscillator strategies, I vote this one the highest. Reason being, the twin peaks strategy accounts for the current setup of the stock. The twin peaks is also a contrarian strategy as you are entering short positions when the indicator is above 0 and buying when below 0.
Therefore, the verdict is in and I am giving the twin peaks strategy a solid C+.
#4 - Bonus Strategy
You will not find this strategy anywhere on the web, so don't waste your time looking for it.
Going back to the crossing of the 0 line, what if we could refine that a little to allow us to filter out false signals, as well as buy or short prior to the actual cross of the 0 line.
This approach would keep us out of choppy markets and allow us to reap the gains that come before waiting on confirmation from a break of the 0 line.
I am going to coin the setup as the Awesome Oscillator (AO) Trendline Cross
Long Setup - AO Trendline Cross
Awesome Oscillator has two swing highs above the 0 line
Draw a trendline connecting the two swing highs down through the 0 line
Buy a break of the trendline
AO Trendline Cross
As you can see in the above example, by opening a position on the break of the trendline prior to the cross above the 0 line, you are able to eat more of the gains.
The other point to note is that the downward sloping line requires two swing points of the AO oscillator and the second swing point needs to be low enough to create the downward trendline.
Bearish Setup - AO Trendline Cross
Awesome Oscillator has two swing lows below the 0 line
Draw a trendline connecting the two swing lows up through the 0 line
Sell Short a break of the trendline
Bearish AO Trendline Cross
In this example the cross down through the uptrend line happened at the same time there was a cross of the 0 line by the AO indicator. After the break, the stock quickly went lower heading into the 11 am time frame.
In Summary
The most popular awesome oscillator trading strategies aren't that great, but of the three, the twin peaks is the best. However, after reading this article I hope you will go out and evangelize the AO Trendline Cross to the masses.
