Week 12 oscillators (1)

FINA 33005D Week 12 Agenda: Momentum and Oscillation Intro Having introduced channels and momentum, it is easy to see why traders use oscillation to substantially increase the profitability of their trades. Channels indicate the trading range a stock can have over any given period, momentum measures rate of change, oscillation illustrates where within that trading range a stock is moving on the supposition that a stock is generally either overbought or over sold. Key Takeaways Oscillators are momentum indicators used in technical analysis, whose fluctuations are bounded by some upper and lower band. Since stock prices are mean reverting, in the absence of corporate/sector development, when oscillator values approach band boundaries, they provide overbought or oversold signals to traders. Since stock prices are mean reverting, oscillators are often combined with moving average indicators to signal trend breakouts or reversals. Stocks do not breakout or reverse at the same points, or do not stay over-extended for the same length of time. Oscillators just show how momentum has affected current pricing and whether stocks are currently exposed to the risk of changing direction. How Oscillators Work Oscillators are typically used in conjunction with other technical analysis indicators to make trading decisions. Analysts find oscillators most advantageous when they cannot find a clear trend in a company's stock price easily, for example when a stock trades horizontally or sideways. The most common oscillators, which you should review in your text include the stochastic, relative strength, rate of change and money flow. Much like using standard deviation, the oscillator uses a mean as its midpoint and it moves on either side of that value illustrating a short term trend. When the investor sees that the oscillator moves toward the higher value, the investor reads the asset as overbought and In the opposite scenario, when the oscillator trends towards the lower value, the investors consider the asset oversold. Key Takeaways A Divergence between the oscillator and the price action when the oscillator is in an extreme position is usually an important warning of a reversal
The crossing of a zero (or midpoint) line can give important trading signals in the direction of the price trend. Popular Types of Oscillators Note: You should be able to differentiate these oscillators and understand what they measure but the formulas below are just for illustration, you are not tested on their math. 1) Relative Strength Index Relative strength index (RSI) was introduced in 1978 by J. Welles Wilder. It ranges between 0 and 100 and compares the magnitude of a stock's recent gains/losses with the stock's pricing action over a given time period (14-day RSI is most popular). RSI= 100 - 100/1+RS As with any other oscillator, buying and selling signals are generated when value of relative strength index crosses defined boundaries. If RSI closes above 70, value of security is overbought and selling signal is generated. If value crosses below 30, security is oversold and buying signal is generated. When stock is in up trend, then the overbought levels are 80 and oversold when approaching 40. When stock is in down trend, then the overbought levels are 60, and oversold are around 20. 2) ADX (ADX with DMI) The Indicator ADX, also known as Average Directional Index, is based on the movements of the Prices and is a directional movement Indicator; it measures the strength of the Trend and is one of the most important and used Indicators. While the DMI, also known as Directional Movement Index, is composed by the -DI (Minus Directional Indicator) and the +DI (Plus Directional Indicator); it works as the Average Directional Index and it's used to measure the strength of the Trend. These two Indicators, are used together on the same Chart that we want to analyse. - The ADX and DMI measure the strength of a Trend, not the current direction of the Trend. - The value of the ADX can oscillate between 0 and 100. - The value of the DMI can oscillate between 0 and 100. - The ADX can be considered as the "Moving Average" of the DMI. - The DMI is composed by the +DI (Red line on the chart) and -DI (Blue line on the chart): the longer the distance between the two lines is, the stronger will be the current Trend.
W hen the value of the ADX is below 20, it means that the current Trend in the Prices is very weak (Or it means that there is not a "real" Trend); whereas if the value of the ADX is above 25, it means that there is a strong Trend in the Prices. In case that the value of the ADX is above 40, that would be a signal of a very strong Trend. - When the +DI line is above the -DI line, it's possible that there will be a rise in the Prices; whereas if the +DI line is below the -DI line, it's possible that there will be a decline in the Prices. - If the ADX is above the value of 25, while the +DI line breaks above (Goes from below to above) the -DI line, it's a signal of a possible rise in the Prices. Whereas if the ADX is above the value of 25, while the -DI breaks above (Goes from below to above) the +DI line, it's a signal of a possible decline in the prices. 3) Stocastics -George Lane's Stochastic Oscillator had been the classic oscillator since its invention decades ago. Common Default Value: Stochastic(14,3) The Stochastic plots with two values: %K and %D. As an example, consider the price range of the past two weeks. If the price is near the top of this range, the two-week Stochastic produces a high %K value. If price hovers near the bottom of the range, it gives a low %K value. The %D line, which is usually a 3-period moving average of %K, acts as the trigger line. If the market is at the extreme (high or low) of the recent trading price range, there is clearly strong momentum in one direction. But the momentum might be unsustainable. Hence, there are overbought and oversold zones. Stochastic values above 80 -> Overbought (look to sell) Stochastic values below 20 -> Oversold (look to buy) Combining both the %K and %D lines offers exact signals. %K crossing below %D -> Sell signal %K crossing above %D -> Buy signal 4) Commodity Channel Index (CCI)
Uploaded by Amanda2157 on coursehero.com