Besides the common momentum
or 'overbought/oversold' type technical indicators of the Relative Strength Index (RSI), Stochastics and MACD, there are 4 other indicators of the same type you may see listed: Rate Of Change (ROC), Momentum, and the William's Percent R (%R) and Ultimate Oscillator. Some of these indicators are also called oscillators
if they have a 'fixed scale' (e.g., 0 to 100) and 'oscillate' between set limits. ROC and Momentum are of possible interest (and I'll go into in some depth); the Williams two add complexity but don't usually reveal much more about the trend or possible trend reversals than the more common RSI, Stochastics or MACD. Before I plunge into the topic de jour, here's an update.
THIS WEEK'S MARKET: SOME TECHNICAL ASPECTS
The S&P 500 (SPX) has a resistance zone at 1173-1182 that it needs to overcome on its way to a potential challenge of its prior (intraday) 12-month high at 1220. Currently, the index is struggling some to overcome this area. Piercing 1182 made this level the technical 'breakdown' point after the top formed in late-April/early-May. Technically, one problem with immediately overcoming resistance in this zone is the overbought extreme 'signaled' by the second RSI reading at 70.
The 70 and above RSI level, normally seen as a type of extreme, doesn't always pan out that way as you can see on the daily SPX chart below. The last instance of RSI at 70 or above was on 9/20 when the index closed at 1142. Yesterday, (10/13/10) the RSI closed at 1178, with the RSI again in the 70 area. Sometimes in strong bull trends, just when you think overbought/oversold technical models of this type don't mean all that much, there's a correction, even if it's more of a sideways stall for awhile rather than much of dip.
I've added to the chart above, the Percent R (%R) indicator, the first of the two indicators I mentioned that were invented by Larry Williams, a well-known futures market trader and analyst of past decades. The way that my TradeStation application renders Larry's study is that 80 and above is the 'overbought' zone and 20 and below, 'oversold'. Frankly I have never been able to any significant further inputs in terms of (overbought/oversold) extremes or, more importantly to me, bullish or bearish price/RSI divergences. In fact, I find RSI to better show real 'extremes' in an index or stock.
Moreover, the way MY charting application (TradeStation) render's the %R indicator is contrary to way you usually see it, which is shown below. Williams %R indicator is usually plotted using negative values (e.g., -20%). Readings in the range of -80 to -100 suggest that a stock or index is oversold, while readings in the range of 0 to -20 suggest an overbought situation. Although the effect is the same in terms of high is overbought and low is oversold, I don't like working with negative numbers usually in indicators. And, as I said, I find the Relative Strength Index to be a superior indicator.
As for my current take on the Nasdaq, we might as well look at the leading light of this market and examine the big cap Nasdaq 100 (NDX) index seen next. Recent highs (10/13-10/14/10) suggest that NDX is hitting technical resistance implied especially by its prior Closing high at 2055 and secondarily by the resistance trendline defined by the line of prior highs. Here also, the Relative Strength Index or RSI is not 'confirming' a similar new high, which makes for a potential bearish divergence. I don't like still being in, for example, index calls when this type of divergence sets up, one that doesn't always signal a top, (which if it occurred, would be a double top) but I've been forewarned enough times in the past where it did.
As the potential for a top is there, I figure why take the risk, assuming I've bought 'right'; e.g., buying right for me would have meant adopting bullish options strategies when NDX was last in the RSI oversold area when NDX bottomed at 1760-1750. That bottom was a classic island bottom formation. For more on this pattern and the chart 'gaps' that precede and follow such a bottom click here.
I included with my NDX chart above this time the addition of the second Larry Williams indicator mentioned, that of the "Ultimate" Oscillator. I think that the modifier "ultimate" here ought to be in quotes. Again, with this indicator, I haven't found that this technical model has offered more value than the RSI, Stochastics or MACD indicators. Moreover, the 'rules' of use are more complex. Basically, as with the other more commonly used oscillators, the rules are similar for bullish or bearish divergences; i.e., a new high in prices not followed by a new high in the technical indicator and a new low in a price swing not matched by a similar new low in the oscillator. I have somewhat over-simplified the rules of use here as there are also rules for when to close out a long or short position.
So far, in my 'basics of technical analysis' series, I have written about this similar class of technical indicators:
The Relative Strength Index (RSI) : see online link here.
The Stochastics indicator: see online link here.
The Moving Average Convergence Divergence (MACD): see link here.
The Williams %R overbought/oversold indicator
and the Williams Ultimate Oscillator
I've discussed just briefly in conjunction with my SPX and COMP charts above. These are ones I wanted to classify but I haven't found them as worthwhile for me to use so haven't gone into them in much depth.
Last but not least, two final indicators of this similar class of indicators are:
(PRICE) RATE OF CHANGE and MOMENTUM INDICATORS
The Rate-of-Change (ROC) indicator displays the difference between the current price and the price x number of periods ago. The setting for the number of periods is what you can input. The difference can be displayed either in points or as a percentage. The Momentum indicator displays the SAME information as the ROC model but as a ratio.
The Momentum indicator is a type of technical indicator that calculates and plots the net price change, expressed in points, between the close of any two bars. Although I cite the common use of the closing price only, this is not the only possibility as comparisons for the open, high or low could also be made.
It is also necessary to set some number of bars or period being measured, whether in use on an intraday, daily or weekly chart, which is the momentum oscillator's 'length' setting; e.g., a 10-day momentum indicator would be today's close minus the close of 10 days ago, as seen in an historical chart of Apple (AAPL) below:
A 10-hour or 10-week momentum could also be established provided you have hourly or weekly data. Measuring current prices versus earlier prices sheds light on the pace of a trend relative to whether it is slow or fast. If fast and steep, there is always also the possibility of a trend reversal. Examination of past reversals in that stock or index is useful in identifying levels that represent overbought and oversold conditions, which is when momentum is very strong, either in an up or down direction.
The Rate of Change (ROC) oscillator seen below shows virtually the same kind of change as the momentum model, only the scaling is different (ROC is a fraction); the ROC indicator takes a current bar's price and divides by the price of X number of bars' ago; e.g., 10 days ago. The ROC calculation creates a ratio, rather than a price differential.
An example of the ROC indicator is shown below, along with the same 10-day length Momentum indicator for comparison, using the same time frame or length setting for both indicators. You'll note on the Rate of Change indicator below and with the Momentum model in the chart above, a middle line called the 'zero' or equilibrium line.
The concept of a zero or midpoint line indicates that readings above the line are a positive number, suggesting a bullish advancing rate of change whereas readings below the midpoint line imply a bearish or declining momentum. In an uptrend, the current close will generate a reading above the zero line, which is easily seen with these indicators, but is not always the case on the price chart, especially in a sideways trend or an area of price congestion; i.e., a cluster of closes around the same price.
When either ROC of Momentum indicators are well above or below the zero or midpoint line, it provides a visual indication of strong upside or downside momentum. When distances above or below the horizontal midpoint (zero) line is more moderate, upside or downside momentum indicated for that stock or index is of course more moderate.
Some of the extremes noted on the chart examples above correspond to tops and bottoms and some did not. The strongest trends will usually have the greatest extremes. As always, combining the analysis of a pullback in an oscillator line from an up or down extreme, with what is going on with volume, prior tops and bottoms, moving averages and trendlines will provide the ancillary or related clues about actual reversals in the trend versus where the these indicators are simply reflecting fluctuations within the same trend.
Strictly speaking, a momentum or ROC crossover above the line (whether it's referred to as the midpoint, zero or equilibrium line) is a bullish, or 'buy' type indication. If a price drop pulls the indicator line below the midpoint line this is a bearish, or 'sell' type indication.
Traders will use such upside or downside crossover signals in various ways, and it may be simply be to look for selling opportunities only when the line is at a high point relative to past weeks and to look for buying opportunities when the line is well below the midpoint, indicating downward momentum and also at a low point extreme relative to the chart's past history.
A shorter length selected for either indicator, will result in a more sensitive reaction. Shorter time frames on daily charts, like 5 or 9-day periods, will generate both more fluctuations and more indications of 'overbought' or 'oversold' extremes.
Shorter lengths are of potential use to (who else!) short-term traders, but even traders that are geared to profit from smaller price swings will find that they can easily get whipsawed in their trading efforts; e.g., buying at what appears to be an oversold reading in terms of the ROC or Momentum indicators, only to witness a further drop. I always caution against using ANY technical indicator in a 'mechanical' way unless the indicator is part of a trading system which has been tested over time and includes stop-loss or exiting rules.
GOOD TRADING SUCCESS!