|
Trading
without indicators is like running blind and it encourages emotional trading
that is the bane of successful investment and speculation. It is hard to know
what to buy or sell let alone just when to do prudently. Thank goodness there
are indicators available that provide information of stock and index movement
of a more immediate nature making life during these times somewhat more
bearable.
There
are over 80 such indicators divided into 6 categories. The most popular
indicators, and also available for use free at online charting service such
as stockcharts.com and/or bigcharts.com, are the trend (See: http://www.munknee.com/2010/07/timing-the-market-using-trend-indicators/),
momentum, market strength and volatility categories. This article will deal
with the 6 most popular Momentum Indicators as follows:
Momentum
Indicators
At its
most fundamental level, momentum is a means of assessing the relative levels
of greed and fear in the market at any given point in time. Securities ebb
and flow, surge and retreat, and such action is measured by oscillators which
are powerful leading indicators of the security’s immediate direction
and its speed.
Oscillators
are most useful and issue the most valid trading signals when their readings
diverge from prices. A bullish divergence occurs when prices fall to a new
low while an oscillator fails to reach a new low. This situation demonstrates
that bears are losing power, and that the bulls are ready to control the
market for the stock or index again and such divergence often marks the end
of a downtrend. Bearish divergences signify up-trends, when prices rally to a
new high while the oscillator refuses to reach a new peak. In this situation,
bulls are losing their grip on the security, prices are rising only as a
result of inertia, and the bears are ready to take control again.
The 6
Most Useful Momentum Indicators
1.
Stochastic Oscillator (SO)
SO
compares a security’s closing price to its price range over a given
period of time. The theory behind this indicator is that in an upward-trending
market, prices tend to close near their high, and during a downward-trending
market, prices tend to close near their low.
There
are two components to the SO: the %K which is the main line indicating the
number of time periods (usually 14), and the %D which is a three-period
moving average of the %K. Buy/sell signals occur when the %K crosses
above/below the %D. A %K result of 70 (or 30), for example, is interpreted to
mean that the price of the security closed above 70% (or below 30%) of all prior
closing prices that have occurred over the past 14 days and assumes that the
security’s price will trade at the top (or at the bottom) of the range
in a major uptrend (or downtrend). A move above 80 suggests that the security
is overbought and therefore should be sold while a move below 20 suggests
that the stock or index is oversold and, as such, is a buying signal.
The
SO, which ignores market jolts, is an ideal companion to the MACD to provide
an enhanced and more effective trading experience. Using the two together
gives traders an opportunity to hold out for a better entry point on an
up-trending security or to be more sure that any down-trend is truly
reversing itself when bottom-fishing for long-term holds. However, on the
downside, because the stock or index generally takes a longer time to line up
in the best buying position, the actual trading of the security occurs less
frequently, so you may need a larger basket of stocks to watch.
2. Relative
Strength Index (RSI)
RSI
compares the magnitude of recent gains in price to recent losses in an
attempt to determine overbought and oversold conditions of a security.
The
RSI, on a scale of 0-100, indicates that a stock is overbought when it is
over 70 and oversold when it is below 30. Because large surges and drops in
the price of a security will create false buy or sell signals the RSI works
best when it is used in conjunction with short-term moving average crossovers
such as the Stochastic Oscillator to confirm a directional shift.
3. StochRSI
StochRSI
was created by applying the Stochastic Oscillator to the Relative Strength
Index values rather than standard price data thereby giving the trader a
better idea of whether the current RSI value is overbought or oversold
– a measure that becomes specifically useful when the RSI value is
confined between its signal levels of 30 and 70.
4. TRIX
TRIX
displays the percent rate-of-change of a triple exponentially smoothed moving
average of a security’s closing price and is designed to filter out
stock movements that are insignificant to the larger trend of the security.
The
user selects a number of periods (such as 15) with which to create the moving
average, and those cycles that are shorter than that are filtered out. TRIX
is also a leading indicator and can be used to anticipate turning points in a
trend through its divergence with the security’s price.
5. Commodity
Channel Index (CCI)
CCI is
an oscillator which quantifies the relationship between the security’s
price, a moving average of the security’s price, and normal deviations
from that average to determine when a security has been overbought or
oversold.
The
CCI, when used in conjunction with other oscillators, can be a valuable tool
to identify potential peaks and valleys in the security’s price, and
thus provide investors with reasonable evidence to estimate changes in the
direction of price movement of the security.
6. Price
Rate of Change (ROC)
ROC
measures the percentage rate of change, indicating the strength of the
momentum, between the most recent price and the price over “x”
periods (the narrower the better) thereby identifying bullish or bearish
divergences. As such, the ROC is able to forecasts sooner than almost any
other indicator an upcoming reversal of a trend and whether or not a
security’s price action is created by those over-buying or over-selling
it. A number other than zero (a personal choice) can be used to indicate an
increase in upward momentum and a number less than zero to indicate an
increase in selling pressure.
Conclusion
There you have it
– an extensive and in-depth assessment of how to evaluate when you
should be buying or selling particular stocks, warrants, ETFs, gold, silver
or any other type of security.
Lorimer Wilson
MunKnee.com
Lorimer
Wilson is Editor of www.FinancialArticleSummariesToday.com (F.A.S.T.) and www.MunKnee.com (Money, Monnee, Munknee!) and an economic analyst and financial
writer. He is also a frequent contributor to this site and can be reached at
editor@munknee.com.
|
