How to read an options risk/reward graph
Major Candlestick Patterns
The 17/43 Weekly Exponential Moving Averages
The 5-35 oscillator
The MACD Indicator
Developed by Gerald Appel, the Moving Average Convergence/Divergence Indicator (MACD) is one of the simplest and most reliable indicators available today. The first line created is the MACD Graph (thick black line) and is calculated by taking the difference between the 26 day Exponential Moving Average (EMA), based on closing price, and the 12 day EMA, which creates a momentum oscillator that oscillates above and below zero. The second line created is the MACD trigger line (thin red line) which is a smoothed, 9 day EMA of the MACD graph.
The Relative Strength (RSI) Index
The Relative Strength Index (RSI) is a popular momentum oscillator that was developed by J. Welles Wilder. The RSI compares the magnitude of a stock or index’s recent gains to the magnitude of its recent losses and converts this information into a number that ranges from 0 to 100. Below is an example of the DOW index with its 20, 50, 100 and 200 day simple moving averages (SMA), and the RSI oscillator.
The Average Directional Index (ADX or DMI) Technical Indicator
The Average Directional Index (ADX), developed by J. Welles Wilder Jr. and also sometimes called the Direction Movement Index, or DMI, is used to evaluate the strength of a trend, be it up or down. The ADX indicates when a trend is present and the overall strength of the trend. The higher the ADX the stronger the trend.
The ADX system comprises three lines; +DI,–DI and the ADX line.
A) Positive Directional Indicator (+DI; thin green line) indicates the strength of upward price pressure
B) Negative Directional Indicator (–DI; thin red line) indicates the strength of downward price pressure
C) Average Directional Index (ADX line; thin black line) shows the overall strength of a trend without regard to direction. The higher the ADX, over 20, the stronger the trend.
The Accumulation/Distribution Line (A/D line) was developed by Marc Chaikin and is one of the popular volume flow indicators to assess the early cumulative flow of money into and out of a security, which can anticipate price moves of the stock. An up-trending A/D Line suggests that buying pressure is building on higher volume, and a down-trending A/D Line indicates that selling pressure is building on higher volume. The basic premise behind the A/D line is that an increase in the volume of shares traded, e.g. per day, will precede an eventual move in the price of the stock. Many times before a stock advances there will be a period of increased volume in the stock on the UP days just prior to the price move of the stock. The A/D line focuses on the price action for a given period (e.g. daily) and generates a value based on the location of the close, relative to the range for the day. We will call this value the “Close Location Value” or CLV. The CLV ranges from plus one to minus one with the center point at zero. Below is a summary of the the rules to calculate CLV.(more…)
Chaikin Money Flow
Bollinger Bands are widely used by professional traders and fund managers, and are designed to answer the question whether the price of a stock or index is high or low on a relative basis. Armed with this information, traders can make buy and sell decisions by using additional technical indicators to confirm price action of the stock or index they are trading. The Bollinger band does not give absolute buy and sell signals simply by having been touched; rather, it provides a framework within which price may be related to other technical indicators.
Bollinger Bands are formed by calculating two standard deviations around a 20 day simple moving average of an underlying index or stock. Two standard deviations include about 95% of the chart’s price data between the two trading bands. Because the standard deviation calculation is based on volatility, as the stock or index’s volatility changes the width of the “envelope” will increase or decrease correspondingly.
ISE Call/Put Ratio Sentiment Index (ISEE)
The International Securities Exchange (http://www.ise.com) equity only call/put ratio investor sentiment index (ISEE) is more refined than traditional put/call ratios because it only uses opening long customer transactions to calculate bullish/bearish market sentiment. Opening long transactions, i.e. where the investor “buys-to-open” a call or put leg, are thought to best represent market sentiment because investors often buy call and put options to express their actual market view of a particular stock. Short orders (i.e. sell-to-open) are excluded since myriad options strategies could be involved and thus are not representative of true investor sentiment. Furthermore, trades from market makers and institutional broker/dealers are excluded since their trades are usually part of more complex trades, such as spreads, butterflies, diagonals…etc. so these trades can “muddy the waters”. As a result, the ISEE calculation method allows for a more accurate measure of true investor sentiment than traditional put/call ratios. Moreover, the ISEE focuses on equities only and does not include options opened on ETFs and indexes, because many of the trades on ETFs and Indexes are used as hedging instruments, so they reflect less accurately on true investor sentiment.(more…)
Investors Intelligence Bull/Bear Ratio Measuring Investor Sentiment
McClellan Oscillator & Summation Index
The McClellan Oscillator is one of the more accurate and modernized market breadth indicators available and is based on the smoothed difference between the number of advancing and declining issues on a broad-based index, such as the NYSE Composite, the S&P 500 Index, or the NASDAQ Composite.
We are interested in monitoring market breadth because it tells us what percent of the market is actually participating in a rally or a sell-off. Because many of the broad-based indexes are market-cap weighted (market cap = number of outstanding shares * share price), sometimes just a handful of the largest companies that reside in an index can artificially move the index. For example, if Exxon and Chevron both rally 1.5% due to a positive energy report, because these two companies represent 5% of the S&P 500 index, these two companies alone could move the index; however, the remaining 498 stocks might have all closed down or flat for the day and we wouldn’t have known it. Therefore, it’s prudent to watch a market breadth indicator, like the McClellan Oscillator, to provide us a more accurate picture of what “all” of the stocks are doing in the index.(more…)
The Stochastic Oscillator is a technical momentum indicator that compares a security’s closing price to its price range over a given time period, usually 14 periods. (1 period = 1 day for this example) This indicator is calculated with the following formula:
%K = 100[(C – L14)/(H14 – L14)]
%D = Smoothed, 3 day simple moving average of %K
C = the most recent closing price
L14 = the low of the 14 previous trading sessions
H14 = the highest price traded during the same 14-day period
As an example, below is a table of daily highs, lows and closing prices for a particular index over 14 trading days. On day 14, %K would be calculated as shown below where C=115.38, L14=109.13, and H14=119.94.(more…)
Williams %R Indicator
Developed by Larry Williams, Williams %R, also known simply as %R, is a momentum indicator that is popular for measuring overbought and oversold levels. The scale ranges from 0 to negative 100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold. The %R indicator shows the relationship of the close relative to the high-low range over a set period of time, usually 9, 14 or 28 days. The nearer the close is to the top of the range, the nearer to zero (higher) the indicator will be. The nearer the close is to the bottom of the range, the nearer to -100 (lower) the indicator will be. If the close equals the high of the high-low range, then the indicator will show 0 (the highest reading). If the close equals the low of the high-low range, then the result will be -100 (the lowest reading).(more…)
Advance/Decline Ratio Oscillator (ADRO)
The advance/decline line is a popular market breadth indicator. It is a simple measure of how many stocks are taking part in a rally or sell-off and it’s usually calculated from NYSE stocks. The A/D line is calculated as follows:
A/D Line = (number of advancing stocks for the day – number of declining stocks for the day) + yesterday’s A/D line value
The Advance/Decline Ratio Oscillator (ADRO) is a variation on the advance/decline line where it accounts for total market volume beyond the NYSE. The ADRO has a tendency to identify near-to-intermediate tops when the indicator is above 4.00, and near-to-intermediate bottoms when the indicator is at -2.00 or below. Chart courtesy of Market Harmonics.
Elliott Wave Analysis
Aruoba Diebold Scotti Business Conditions Index (ADS)
The ADS Index is one of several macro-level indicators tracking the overall health of the US economy. This index is a diffusion of 6 economic components: Weekly initial jobless claims; monthly payroll employment; industrial production; personal income less transfer payments; manufacturing and trade sales; and quarterly real GDP. The ADS index is updated in almost real-time with “high-frequency” economic data.
The average value of the ADS index is zero. Progressively bigger positive values indicate progressively better-than-average conditions, whereas progressively more negative values indicate progressively worse-than-average conditions. The ADS index may be used to compare business conditions at different times. A value of -3.0, for example, would indicate business conditions significantly worse than at any time in either the 1990-91 or the 2001 recession, during which the ADS index never dropped below -2.0.(more…)