Subscription

Technical ToolBox

1. The Simple Moving Average (SMA)

 

The simple moving average is probably the most widely used and most popular indicator of all. It is a trend-following or lagging indicator as it based on past prices.

 

The simple moving average is an average of the closing prices for the last ‘N’ periods. For example, a 5-day moving average will be an average of closing prices for the last 5 days, rolled forward one day at a time.

 

The direction of the moving average shows a general idea of which way the price is moving. Moving averages with shorter timeframes tend to stay close to prices and will move right after prices move. Longer timeframes have much more cumbersome data and their moves lag behind the market’s move much more significantly. As for what time frames should be used, it really is up to the trader’s preference and trading styles. Typically, any period under 20 days would be considered short term, anything between 20 and 60 would be medium term and of course anything longer than 60 days would be viewed as long term.

 

Moving Average Crossover

  • The shorter term SMA crosses above the longer term SMA creates a bullish signal known as ‘Golden Cross’. 
  • Conversely, when shorter term SMA crosses below the longer term SMA creates a bearish signal known as ‘Dead Cross’. 
  • ‘Bullish Price Crossover’ happens when price crosses above the shorter term SMA while the shorter term SMA already crossed above the longer term SMA.
  • ‘Bearish Price Crossover’ happens when price crosses below the shorter term SMA while the shorter term SMA already crossed below the longer term SMA.

ASX200 Daily: Golden Cross & Bullish Price Crossover

 

 

ASX200 Daily: Dead Cross & Bearish Price Crossover

 

Moving averages are an important analytical tool used to identify current price trends and the potential for a change in an established trend. Nevertheless, we must also be aware that moving average indicators work best in trending markets. In periods of choppy markets when prices fluctuate in a particular price range they do not work at all. If the market is sideways and directionless, then there is a greater chance of being 'whipsawed'.

 

 

 

2. Trendline

 

One of the most basic but very important tools used in technical analysis is the trendline. A trendline is a straight line that connects two or more price points.

An uptrend line has a positive slope and is formed by connecting two low points. The second low must be higher than the first for the line to have a positive slope. In another word, if price makes higher lows and higher highs, we can draw an uptrend line by connecting the two lows.

 

Up Trend Line: Silver Daily

 

Conversely, A downtrend line has a negative slope and is formed by connecting two high points. If price makes lower high and lower lows, we can draw a downtrend line by connecting the two highs.

 

Down Trend Line: GBPNZD Weekly

 

By drawing trend lines, we can easily identify positive and negative trending charts. The trendline also shows the potential support and resistance levels. We can simple buy near the uptrend lines and sell near the downtrend lines.

 

If the price break either the uptrend or downtrend lines, it will also signal a possible change in the trend. We can sell after price broke the uptrend lines and buy after price broke the downtrend lines.

 

Simple trading strategy illustration (CSL Weekly)

  • buy near the uptrend line
  • sell after broke the uptrend line

 

 

 

3. Moving Average Convergence Divergence – MACD

 

The MACD is a very popular used indicator in technical analysis. It measures the changes in momentum of prices.  The values of 12, 26 and 9 are the common setting used with the MACD.

 

The MACD indicator has the following three components:

  1. MACD Line
    • MACD Line is created from the difference between a longer term EMA (Exponential Moving Average) and a shorter term EMA
    • Calculation based on common setting: 12-day EMA – 26-day EMA
  2. Signal Line
    • The signal line is an EMA of the MACD Line
    • Calculation based on common setting: 9-day EMA of MACD Line
  3. MACD Histogram:
    • The MACD histogram takes that difference between MACD Line and Signal Line. When the MACD histogram is above the Zero Line, the MACD is considered positive and when it is below the Zero Line, the MACD is considered negative.
    • Calculation: MACD Line – Signal Line

Interpretation

Signal Line Crossovers

  • A Bullish Signal Line Crossovers occurs when the MACD turns up and crosses above the signal line.
  • A Bearish Signal Line Crossovers occurs the MACD turns down and crosses below the signal line.

Example: Silver Daily

 

 

Centreline (Zero Line) Crossovers

  • A Bullish Centreline Crossover occurs when the MACD Line crosses above the Zero Line and go from negative to positive.
  • A Bearish Centreline Crossover occurs when the MACD Line crosses below the Zero Line and go from positive to negative.
  • If the is above zero it helps confirm an uptrend; below zero and it helps confirm a downtrend.

Example: Silver Daily

 

 

 

Divergence

  • A Bullish Divergence occurs when price records a lower low, but the MACD forms a higher low.
  • A Bearish Divergence occurs when price records a higher high, but the MACD forms a lower high.

Example: Silver Daily

Divergence is a useful tool and warns a trend has slowed down, but this doesn’t mean price will reverse. We should be aware that Bearish Divergences are commonly occur in a strong uptrend whereas Bullish Divergences often occur in a strong downtrend.

 

 

4. Relative Strength Index – RSI

 

The relative strength index (RSI) developed by J. Welles Wilder is one of the most popular oscillator indices.

The RSI is classified as a momentum oscillator, measuring the velocity and magnitude of directional price movements. It is calculated using the following formula:

RSI = 100 – [100 / (1 + RS)]

Where RS = Average gain of up periods during the specified time frame / Average loss of down periods during the specified time frame.

The RSI is commonly used on a 14 period time frame, measured on a scale from 0 to 100.  According to Wilder, any number above 70 should be considered overbought and any number below 30 should be considered oversold.

 

 

 

Interpretation

Divergence

  • Bullish RSI Divergence occurs when price makes a new lower low but RSI makes a higher low.
  • Bearish RSI Divergence occurs when price makes a higher high but RSI makes a lower high.

Bullish Divergence: Gold (XAU/USD) Daily

 

Bearish Divergence: DAX 30 Index Daily

 

 

 

Failure Swings

Wilder also considered failure swings as strong indications of an impending reversal.  Failure swings focus solely on RSI for signals and ignore the concept of divergences.

  • A Bullish Failure Swing consists the following 4 stages
    1. RSI drops below 30 (considered oversold).
    2. RSI bounces back above 30.
    3. RSI pulls back but remains above 30 (remains above oversold)
    4. RSI breaks out above its previous high.
  • A Bearish Failure Swing
    1. RSI rises above 70 (considered overbought)
    2. RSI drops back below 70
    3. RSI rises slightly but remains below 70 (remains below overbought)
    4. RSI drops lower than its previous low.

Bullish Failure Swing: AUD NZD Daily

Bearish Failure Swing: AUD CNY 2 Hours

 

 

 

 

5. Stochastic Oscillator (STOCH)

 

The stochastic oscillator is a momentum indicator that was developed by George C. Lane in the late 1950s. It consists two lines that move between 0 and 100. The first line (known as %K) displays the current close in relation to a user-defined period's high/low range. The second line (known as %D) is a simple moving average of the %K line.

 

It is calculated using the following formula:

  • %K = (Current Close - Lowest Low) / (Highest High - Lowest Low) * 100
  • %D = 3 day SMA of %K

Note:

  • Lowest Low = lowest low for the look-back period
  • Highest High = highest high for the look-back period
  • %K is multiplied by 100 to move the decimal point two places

 

The default setting for the Stochastic Oscillator is 14 periods. A 14-period %K would use the most recent close, the highest high over the last 14 periods and the lowest low over the last 14 periods. %D is a 3-day simple moving average (SMA) of %K. This line is plotted alongside %K to act as a signal or trigger line. %K and %D always range between 0 and 100.

 

 

 

 

Interpretation

Overbought/Oversold

The oscillator ranges from zero to one hundred. No matter how fast the price advances or declines, the Stochastic Oscillator will always move within this range. The default thresholds are 20 for oversold and80 for overbought. These are typical levels but may not be suitable for all situations depending on the financial instrument being traded.

If the stochastic oscillator:

  • rises above 80 (overbought zone), the price could fall in the near future. A cross down that occur above 80 would indicate a potential shifting trend lower from overbought levels.
  • falls below 20 (oversold zone), the prices could rise in the near future. A cross up that occurs below 20 would indicate a potential shifting trend higher from oversold levels.

Overbought/Oversold:  GBP CAD 4 hours

We should be aware that overbought does not always mean a bearish move just like oversold does not always mean a bullish move. Many times overbought (oversold) conditions can be a sign of a strengthening trend and not necessarily an impending reversal.

 

 

 

Divergence

According to Lane, the stochastic oscillator does not follow price or volume or anything similar. It follows the speed or momentum of price. As such, bullish and bearish divergences in the Stochastic Oscillator can be used to foreshadow reversals.

Divergence happens when the stochastic oscillator and the price move in opposite directions; this means the general trend is losing its strength, and could lead to a trend reversal.

  • Bullish STOCH Divergence occurs when price makes a new lower low but STOCH makes a higher low.
  • Bearish STOCH Divergence occurs when price makes a higher high but STOCH makes a lower high.

Bullish STOCH Divergence: Commonwealth Bank of Australia (CBA) Daily

Bearish STOCH Divergence: Palladium 2 Hours  

 

6. Average True Range (ATR)

 

Average True Range (ATR) is a volatility indicator originally developed by Welles Wilder. It is important to remember that ATR is not a directional indicator (eg. RSI or MACD), rather It measures the strength of a move. Large ranges indicate high volatility and small ranges indicate low volatility.

The True Range is the largest of the following:

  1. The distance from today’s high to today’s low
  2. The distance from yesterday’s close to today’s high
  3. The distance from yesterday’s close to today’s low

In order for range to be a meaningful tool as a measure of volatility, more than one day’s range must be considered. Wilder recommended a 14-period to calculate the True Range

The ATR is simply an Exponential Moving Average of the above True Range:

 

 

Interpretation

General Rule

  • When the prices are more volatile, the ATR moves up.
  • When the prices are less volatile, the ATR moves down.

Measuring the volatility

The ATR can be used to predict how far the price may move in the near future.  The picture below is the USDSGD Daily chart with an ATR value of 0.0057. This tells us that the volatility of the price is an average of 57 pips over the last 14 days. Therefore, we can expect the price movement on the given day to move by 57 pips.

The picture below is the USDSEK Daily chart. When this pair started a strong uptrend move the ATR also moved up, showing an increasing in volatility. On the other hand, when it entered into a sideways market the ATR steadily dropped accordingly, showing a decreasing in volatility.

 

Traders can use ATR to determine when volatility is increasing and when it is contracting thus to determine the best times to trade. If ATR is a higher value, traders may seek more pips on a specific trade. Conversely, if ATR is indicating volatility is low, traders may temper their trading expectations with smaller limit orders.

 

We should all be aware that Interpreting ATR can be very subjective. ATR does not indicate a trend is about to reverse, or that a trend will continue. It only reflects the interest or the disinterest in price movements or price volatility. ATR is best used as a compliment to more price direction driven indicators.

 

 

7. Keltner Channels (KC)

Keltner Channels is a banded indicator introduced by Chester W. Keltner in his book “How To Make Money in Commodities” in 1960. It consists of a central moving average line plus channel lines at a distance above and below.

This original version of KC started with a 10-day simple moving average of the typical price, where typical price each day is the average of high, low and close:

 

The 10-day SMA of the High-Low range was added and subtracted to set the upper and lower channel lines.

In the 1980s, Linda Bradford Raschke introduced some modifications for the Keltner Channels, such as different average periods or an exponential moving average (EMA) for the middle line or using a multiple of Wilder's average true range (ATR) for the bands.

We will use the following set-up as illustration for Keltner Channels:

  • Upper Band=20 period Moving Average+(2 ×ATR)

  • Middle Line=20 period Moving Average
  • Lower Band=20 period Moving Average-(2 ×ATR)

 

 

 

Interpretation

Overbought and Oversold: Sideways Market

KC could be very useful to identify overbought and oversold conditions within a sideways market as price tend to moving between the two Keltner bands.

  • When the price closes outside the upper band it’s considered overbought and might return to the lower band again
  • Inversely, when the price closes outside the lower band it’s considered oversold and might return to the upper band again

NZD SGD Daily: Overbought (Sell Signal) and Oversold (Buy Signal)

Trend Confirmation: Trending Market

  • During a Bullish Trend, a breakthrough above the upper band or multiple closes with higher highs outside upper band could indicate the continuation of bullish trend.
  • During a Bearish Trend, a breakthrough blow the lower band or multiple closes with lower lows outside lower band could indicate the continuation of bearish trend.

USD MXN Daily: Bullish Trend

 

EUR CNY Daily: Bearish Trend

 

8. Awesome Oscillator (AO)

 

Awesome Oscillator is a trend following momentum indicator that was created by Bill Williams. It is based on the differences in a 34 period and a 5 period simple moving average. The SMA is calculated with the midpoint of each periods bar.

Calculation:

AO=[SMA(H+L)/2, 5 Periods]-[SMA(H+L)/2, 34 Period]

 

H: Highest price, L: Lowest price

 

The AO will fluctuate between positive and negative territory. A positive AO value (above the Zero Line) suggests the short term period is trending higher than the long term period. On the contrary, a negative AO value (below the Zero Line) indicates the short term period is trending lower than the Longer term period.

 

Interpretation

Zero Line Crossing

  • Bullish Crossing: when AO Crosses above the Zero Line
  • Bearish Crossing: When AO Crosses below the Zero Line

S&P MidCap 400 Weekly: Zero Line Crossing

 

 

Bullish & Bearish Saucer

  • Bullish Saucer Setup
    • AO is above Zero Line
    • There are two consecutive red bars and the second red bar is shorter than the first bar
    • The third bar is green
    • Buy the fourth bar on the open
  • Bearish Saucer Setup
    • AO is below Zero Line
    • There are two consecutive green bars and the second green bar is shorter than the first bar
    • The third bar is red
    • Sell the fourth bar on the open

XAUUSD 4 Hours: Bullish & Bearish Saucer

 

 

Twin Peaks

  • Bullish Twin Peaks
    • AO makes two swing lows below the Zero Line
    • The second low is higher than the first low and followed by a green bar
  • Bearish Twin Peaks
    • AO makes two swing highs above the Zero Line
    • The second high is lower than the first high and followed by a red bar

Palladium 4 Hours: Bullish & Bearish Twin Peaks

 

 

9. Directional Movement Index (DMI)

 

The Directional Movement Index (DMI) was developed by J. Welles Wilder in 1978. It helps trader to determine whether an underlying security is trending or not.

DMI has three significant lines.

  • Average Directional Line (ADX)
  • Positive Directional Index (+DI): Measures an upward movement in price
  • Negative Directional Index (-DI): Measures a downward movement in price

Each line is plotted on top of another and ranges from 0 to 100. The default time parameter used is 14 for both the DMI and ADX period.

Calculation:

  1. Calculating the +DI and -DI

To calculate the +DI and -DI we need to find the +DM and -DM (Directional Movement).

+DM and -DM are calculated using the High, Low and Close for each period.

You can then calculate the following:

Current High - Previous High = Up Move

Current Low - Previous Low = Down Move

If Up Move > Down Move and Up Move > 0, then +DM = Up Move, else +DM = 0

If Down Move > Up move and Down move > 0, then -DM = Down Move, else -DM = 0

Once you have the current +DM and -DM calculated, the +DM and -DM lines can be calculated and plotted based on the number of user defined periods.

+DI = 100 times Exponential Moving Average of (+DM / Average True Range)

-DI = 100 times Exponential Moving Average of (-DM / Average True Range)

  1. Calculating the ADX.

ADX = 100 times the Exponential Moving Average(EMA) of the Absolute Value of (+DI- -DI) / (+DI + -DI)

Note: Variations of this calculation typically involve using different types of moving averages, such as an exponential moving average, a weighted moving average.

 

 

 

Interpretation

Trend Strength

The ADX value is a measure of the strength of the trend regardless of the trend direction; the higher the value of ADX, the stronger the trend. According to Wilder, an ADX value greater than 25 generally suggests that the market is trending, and a value less than 20 indicates not trending.

ADX above 25: ASX Share – Blackmore Ltd (BKL) Daily

 

ADX below 20: ASX Share – Suncorp Group Ltd (SUN) Daily

 

 

DI Crossover

Bullish Crossover (Potential Buy Signal)

  • ADX must be over 25
  • The +DI crosses above the -DI.
  • The signal strengthens if ADX rises.
  • Stop Loss should be set at the current day's low. The signal should not be abandoned, if the low is not breached, even if the -DI crosses above the +DI

Bullish Crossover: ASX Share – Commonwealth Bank of Australia (CBA) Daily

Bearish Crossover (Potential Sell Signal)

  • ADX must be over 25
  • The -DI crosses above the +DI.
  • The signal strengthens if ADX rises.
  • Stop Loss should be set at the current day's high. The signal should not be abandoned, if the high is not breached, even if the +DI crosses above the -DI

Bearish Crossover: US Soybean Meal Daily

Please Note: The DMI crossovers can generate many false signals, other indicators should be used for confirmation of the DMI crossovers.

 

10. Wave Degree Notation

 

 

Wave Degree

5’s with the Trend

3’s against the Trend

1

Supermillennium

1 2 3 4 5

A B C

2

Millennium

(1)(2)(3)(4)(5)

(A) (B) (C)

3

Submillennium

1 2 3 4 5

A B C

4

Grand Supercycle

I II III IV V

a b c

5

Supercycle

(I) (II) (III) (IV) (V)

(a) (b) (c)

6

Cycle

I II III IV V

a b c

7

Primary

1 2 3 4 5

A B C

8

Intermediate

(1)(2)(3)(4)(5)

(A) (B) (C)

9

Minor

1 2 3 4 5

A B C

10

Minute

i ii iii iv v

a b c

11

Minuette

(i)(ii)(iii)(iv)(v)

(a) (b) (c)

12

Subminuette

i ii iii iv v

a b c

13

Micro

1 2 3 4 5

A B C

14

Submicro

(1)(2)(3)(4)(5)

(A) (B) (C)

15

Miniscule

1 2 3 4 5

A B C