Category: Your Money

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This is a review of the 10th chapter of John J. Murphy’s Technical Analysis of the Financial Markets.

Oscillators

Oscillators are extremely useful in non-trending markets and can be used to detect short-term market extremes in trending markets as well. They are most useful when:

1. Their values reach an extreme reading
2. There is divergence between the price action and the oscillator at the extremes
3. There is a zero/midpoint crossing

Commodity Channel Index

The CCI is an index constructed out of comparing the current price with a 20 day average and normalizing it based on mean deviation. The CCI usually falls in a channel of -100 to 100. A basic CCI trading system is: Buy if CCI rises above 100 and sell when it falls below 100. Sell if CCI falls below -100 and buy when it rises above -100.

Relative Strength Index

The RSI is plotted on a scale of 0 to 100. Movements above 70 are considered overbought and below 30 are considered oversold. When a trend develops, an extreme reading in the RSI is typically observed. However, acting on it might make us exit prematurely. It is important to consider the trend of the RSI itself before you act on it.

Williams %R

The %R compares the latest close to the price range over a period of days. It is used in the same fashion as other indicators to identify overbought and oversold conditions.

Moving Average Convergence/Divergence (MACD)

The MACD combines the oscillator approach with exponential moving averages. The faster line (MACD line) is the difference between EMA12 and EMA26. The slower line (Signal line) is a 9 period exponential smoothed MACD line.

1. A Buy is given when the MACD crosses higher than the Signal line.
2. A Sell is given when MACD crosses lower than the Signal line.
3. A Strong Buy is given when #1 occurs and both the lines are below the zero line.
4. A Strong Sell is given when #2 occurs and both the lines are above the zero line.

Additionally, you can use the histogram provided in the charts to get an early warning of crossovers; turns in the histogram back towards the zero line always precede crossovers.

Up Next: Chapter 12 – Candlesticks. Also discussed here. 

Cover via Amazon

This is a review of the 9th chapter of John J. Murphy’s Technical Analysis of the Financial Markets.

Moving Averages

A moving average looks back at the closing prices over a specific number of days (10, 20, 50…) and averages them. It can be used to generate signals.

The Double Crossover Method

A buy signal is generated when the shorter average crosses over the longer. A typical pair is the 10 and 50 day SMAs. Buy when SMA10 crosses above the SMA50, sell if it crosses down.

The Triple Crossover Method

The 4-9-18 day is the most popular system. It is important to understand that SMA4 hugs the trend, followed by SMA9 and then SMA18. Hence, in an uptrend, SMA4 will be above the SMA9 which will be above SMA18. It will be the reverse in a downtrend.

Say the stock is in a downtrend. A buy signal is generated when SMA4 crosses the SMA9 & SMA18. A confirmed buy signal is generated when SMA9 also crosses the SMA18. When the uptrend reverses to the downside, SMA4 will dip below SMA9 (sell alert) and then SMA9 will dip below SMA18 (sell confirmation).

Bollinger Bands

Two trading bands are placed around a moving average. The bands are two standard deviations from the average. i.e., 95% of the price movements will fall between these bands. As a rule, the market is overbought when they touch the upper band and oversold when the touch the lower band. If the prices bounce of the lower band and cross the average, then the upper band becomes a price target. A crossing below the average will identify the lower band as a target.

Also, in a strong uptrend, prices will fluctuate between the upper band and the average and a crossing below the average might warn of a trend reversal to the downside.

One last thing: The width of the bands are directly proportional to the volatility. When the bands are unusually far apart, it is often a sign that the current trend might be ending.

Read more about Bollinger Bands.

Donchian Channel or the 4 Week Rule

The system is:

1. Cover short positions and go long whenever the price exceeds the highs of the four preceding calendar weeks
2. Liquidate long positions and go short whenever the price falls below the lows of the four preceding calendar weeks

 Read more about the Donchain Channel.

Coming Up Next: Chapter 10 – Oscillators