ELLIOTT WAVE

A flat correction differs from a zigzag in that the subwave sequence is 3-3-5, as shown in Figures 1 and 2. Since the first actionary wave,

Fibonacci studies: arcs, fans, retracements, and time

Overview: Leonardo Fibonacci was a mathematician who was born in Italy around the year 1170. It is believed that Mr. Fibonacci discovered..

Indicator

The Negative Volume Index (“NVI”) focuses on days where the volume decreases from the previous day. The premise being that the “smart money” takes positions on days when volume decreases

Basic Technicals

MACD technical analysis MACD technical analysis stands for moving average convergence/divergence analysis of stocks.

Fundamental Analysis

Doubling Stocks Review: Is this a scam? If you are looking for the truth about doubling stocks this is a necessity. One always thought there was something wrong with a doubling of stocks.

Friday, April 9, 2010

Moving Averages


If price movements are choppy and erratic over an extended period of time, then a moving average is probably not the best choice for analysis. The chart for MMM shows a security that moved from 70 to 90 in a few weeks in late April. Prior to this advance, the price gyrated above and below its moving average. After the advance, the stock continued its erratic behavior without developing much of a trend. Trying to analyze this security based on a moving average is likely to be a lesson in futility.
AOL

A quick look at the chart for AOL shows a different picture than for MMM. Over the same time period, AOL has shown the ability to trend. There are 3 distinct trends or price movements that extend for a number of months. Once the stock moves above or below the 70-day SMA, it usually continues in that direction for a little while longer. MMM, on the other hand, broke above and below its 70-day SMA numerous times and would have been prone to numerous whipsaws. A longer moving average would probably work better for MMM, but it is clear that there are fewer characteristics of trend than in AOL.
Moving Average Settings
Once a security has been deemed to have enough characteristics of trend, the next task will be to select the number of moving average periods and type of moving average. The number of periods used in a moving average will vary according to the security’s volatility, trendiness and personal preferences. The more volatility there is, the more smoothing that will be required and hence the longer the moving average. Stocks that do not exhibit strong characteristics of trend may also require longer moving averages. There is no one set length, but some of the more popular lengths include 21, 50, 89, 150 and 200 days as well as 10, 30 and 40 weeks. Short-term traders may look for evidence of 2-3 week trends with a 21-day moving average, while longer-term investors may look for evidence of 3-4 month trends with a 40-week moving average. Trial and error is usually the best means for finding the best length. Examine how the moving average fits with the price data. If there are too many breaks, lengthen the moving average to decrease its sensitivity. If the moving average is slow to react, shorten the moving average to increase its sensitivity. In addition, you may want to try using both simple and exponential moving averages. Exponential moving averages are usually best
for short-term situations that require a responsive moving average. Simple moving averages work well for longer-term situations that do not require a lot of sensitivity.
Uses for Moving Averages
There are many uses for moving averages, but three basic uses stand out:
Trend identification/confirmation
Support and Resistance level identification/confirmation
Trading Systems
Trend Identification/ConfirmationThere are three ways to identify the direction of the trend with moving averages: direction, location and crossovers.
The first trend identification technique uses the direction of the moving average to determine the trend. If the moving average is rising, the trend is considered up. If the moving average is declining, the trend is considered down. The direction of a moving average can be determined simply by looking at a plot of the moving average or by applying an indicator to the moving average. In either case, we would not want to act
on every subtle change, but rather look at general directional movement and changes.
Disney
In the case of Disney, a 100-day exponential moving average (EMA) has been used to determine the trend. We do not want to act on every little change in the moving average, but rather significant upturns and downturns. This is not a scientific study, but a number of significant turning points can be spotted just based on visual observation
(red circles). A few good signals were rendered, but also a few whipsaws and late signals. Much of the performance would depend on your entry and exit points. The length of the moving average influences the number of signals and their timeliness. Moving averages are lagging indicators. Therefore, the longer the moving average is,
the further behind the price movement it will be. For quicker signals, a 50-day EMA could have been used.
The second technique for trend identification is price location. The location of the price relative to the moving average can be used to determine the basic trend. If the price is above the moving average, the trend is considered up. If the price is below the moving average, the trend is considered down.
This example is pretty straightforward. The long-term for ENE is determined by the location of the stock relative to its 100-day SMA. When ENE is above its 100-day SMA, the trend is considered bullish. When the stock is below the 100-day SMA, the trend is considered bearish. Buy and sell signals are generated by crosses above and below themoving average. There was a brief sell signal generated in Aug-98 and a false buy
signal in Nov-99. Both of these signals occurred when Enron’s trend began to weaken. For the most part though, this simple method would have kept an investor in throughout most of the bull move.
The third technique for trend identification is based on the location of the shorter moving average relative to the longer moving average. If the shorter moving average is above the longer moving average, the trend is considered up. If the shorter moving average is below the longer moving average, the trend is considered down.
Support and Resistance Levels
Another use of moving averages is to identify support and resistance levels. This is usually accomplished with one moving average and is based on historical precedent. As with trend identification, support and resistance level identification through moving averages works best in trending markets.

BOLLINGER BANDS

Bollinger Bands are similar to moving average envelopes. The difference between Bollinger Bands and envelopes is envelopes are plotted at a fixed percentage above and below a moving average, whereas Bollinger Bands are plotted at standard deviation levels above and below a moving average. Since standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods.
Bollinger Bands were created by John Bollinger.
Interpretation
Bollinger Bands are usually displayed on top of security prices, but they can be displayed on an indicator. These comments refer to bands displayed on prices.
As with moving average envelopes, the basic interpretation of Bollinger Bands is that prices tend to stay within the upper- and lower-band. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (i.e., low volatility), the bands narrow to contain prices.
Mr. Bollinger notes the following characteristics of Bollinger Bands.Sharp price changes tend to occur after the bands tighten, as volatility lessens.
When prices move outside the bands, a continuation of the current trend is implied.
Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend.
A move that originates at one band tends to go all the way to the other band. This observation is useful when projecting price targets.
Example
The following chart shows Bollinger Bands on Exxon’s prices.

The Bands were calculated using a 20-day exponential moving average and are spaced two deviations apart.The bands were at their widest when prices were volatile during April. They narrowed when prices entered a consolidation period later in the year. The narrowing of the bands increases the probability of a sharp breakout in prices. The longer prices remain within the narrow bands the more likely a price breakout.
Calculation
Bollinger Bands are displayed as three bands. The middle band is a normal moving average. In the following formula, “n” is the number of time periods in the moving average (e.g., 20 days).


The upper band is the same as the middle band, but it is shifted up by the number of standard deviations (e.g., two deviations). In this next formula, “D” is the number of standard deviations.

The lower band is the moving average shifted down by the same number of standard deviations (i.e., “D”).
Mr. Bollinger recommends using “20″ for the number of periods in the moving average, calculating the moving average using the “simple” method (as shown in the formula for the middle band), and using 2 standard deviations. He has also found that moving averages of less then 10 periods do not work very well.

ABSOLUTE BREADTH INDEX

The Absolute Breadth Index (“ABI”) is a market momentum indicator that was developed by Norman G. Fosback.The ABI shows how much activity, volatility, and change is taking place on the New York Stock Exchange while ignoring the direction prices are headed.
Interpretation
You can think of the ABI as an “activity index.” High readings indicate market activity and change, while low readings indicate lack of change.
In Fosback’s book, Stock Market Logic, he indicates that historically, high values typically lead to higher prices three to twelve months later. Fosback found that a highly reliable variation of the ABI is to divide the weekly ABI by the total issues traded. A ten-week moving average of this value is then calculated. Readings above 40% are very bullish and readings below 15% are bearish.
Example
The following chart shows the S&P 500 and a 5-week moving average of the ABI.

Strong rallies occurred every time the ABI’s moving average rose above 310.
Calculation
The Absolute Breadth Index is calculated by taking the absolute value of the difference between NYSE Advancing Issues and NYSE Declining Issues.
ABS(Advancing Issues-Declining Issues)
Absolute value (i.e., ABS) means “regardless of sign.” Thus, the absolute value of -100 is 100 and the absolute value of +100 is also 100.

INDICATORS

Indicators
An indicator is a mathematical calculation that can be applied to a security’s price and/or volume fields. The result is a value that is used to anticipate future changes in prices.
A moving average fits this definition of an indicator: it is a calculation that can be performed on a security’s price to yield a value that can be used to anticipate future changes in prices. I’ll briefly review one simple indicator here, the Moving Average Convergence Divergence (MACD).
MACD
The MACD is calculated by subtracting a 26-day moving average of a security’s price from a 12-day moving average of its price. The result is an indicator that oscillates above and below zero.
When the MACD is above zero, it means the 12-day moving average is higher than the 26-day moving average. This is bullish as it shows that current expectations (i.e., the 12-day moving average) are more bullish than previous expectations (i.e., the 26-day average). This implies a bullish, or upward, shift in the supply/demand lines. When the MACD falls below zero, it means that the 12-day moving average is less than the 26-day moving average, implying a bearish shift in the supply/demand lines.
Figure 28 shows Autozone and its MACD. I labeled the chart as “Bullish” when the MACD was above zero and “Bearish” when it was below zero. I also displayed the 12- and 26-day moving averages on the price chart.

A 9-day moving average of the MACD (not of the security’s price) is usually plotted on top of the MACD indicator. This line is referred to as the “signal” line. The signal line anticipates the convergence of the two moving averages (i.e., the movement of the MACD toward the zero line).
The chart in Figure  shows the MACD (the solid line) and its signal line (the dotted line). “Buy” arrows were drawn when the MACD rose above its signal line; “sell” arrows were drawn when the MACD fell below its signal line.

Let’s consider the rational behind this technique. The MACD is the difference between two moving averages of price. When the shorter-term moving average rises above the longer-term moving average (i.e., the MACD rises above zero), it means that investor expectations are becoming more bullish (i.e., there has been an upward shift in the supply/demand lines). By plotting a 9-day moving average of the MACD, we can see the changing of expectations (i.e., the shifting of the supply/demand lines) as they occur.
Leading versus lagging indicators
Moving averages and the MACD are examples of trend following, or “lagging,” indicators. \[See Figure .] These indicators are superb when prices move in relatively long trends. They don’t warn you of upcoming changes in prices, they simply tell you what prices are doing (i.e., rising or falling) so that you can invest accordingly. Trend following indicators have you buy and sell late and, in exchange for missing the early opportunities, they greatly reduce your risk by keeping you on the right side of the market.

As shown in Figure , trend following indicators do not work well in sideways markets.
Trending prices versus trading prices
There have been several trading systems and indicators developed that determine if prices are trending or trading. The approach is that you should use lagging indicators during trending markets and leading indicators during trading markets. While it is relatively easy to determine if prices are trending or trading, it is extremely difficult to know if prices will trend or trade in the future.

Divergences
A divergence occurs when the trend of a security’s price doesn’t agree with the trend of an indicator. Many of the examples in subsequent chapters demonstrate divergences.

The chart in Figure 34 shows a divergence between Whirlpool and its 14-day CCI (Commodity Channel Index). \[See page .] Whirlpool’s prices were making new highs while the CCI was failing to make new highs. When divergences occur, prices usually change direction to confirm the trend of the indicator as shown in Figure 34. This occurs because indicators are better at gauging price trends than the prices themselves.