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1. FAQ - General
Base Security Concept: The primary focus of a chart is its price plot. Every chart consists of a base security. A base security is simply a security's pricing data.
There are nine different styles of displaying pricing data. Each of these styles uses one or more of the four basic pieces of pricing data--open, high, low, or close. Each of the nine styles has unique differences that can be interpreted in various ways.
Binary Wave: The interpretation of a Binary Wave is fairly obvious: high values are bullish and low values are bearish. (Remember that individual Binary Waves plot as either +1 or -1; the range of composite Binary Waves depends on the number of individual Waves it combines.)
The "Total Wave" system test (shown below) enters long when the indicator rises above zero and sells short when it falls below zero. See Creating a System Test for more information on creating system tests.
| Name | Total Wave |
| Enter Long | fml("Total Wave") < 0 |
| Close Long | fml("Total Wave") > 0 |
| Enter Short | fml("Total Wave") > 0 |
| Close Short | fml("Total Wave") < 0 |
You also could create a "MACD-type" formula by plotting the difference between two moving averages of a composite Binary Wave. Such a formula could be written as follows (name the formula "Smooth Total Wave"):
mov(fml("Total Wave"), 12, E) - mov(fml("Total Wave"), 26, E)
To give you an idea of what a system test for this formula could look like, the Enter Long rule is shown below:
Enter Long : fml("Smooth Total Wave") > 0
Bollinger Bands: Bollinger Bands are specially adapted trading bands that focus on volatility as a key variable. Bollinger Bands were developed by John Bollinger, CFA, CMT. According to John Bollinger:
Sharp moves tend to occur after the bands tighten to the average, i.e., the volatility lessens.
A move outside the bands calls for a continuation of the trend.
Tops and bottoms made outside the bands, which are followed by tops and bottoms made inside the bands, indicate a trend reversal.
A move originating at one band tends to go to the other band.
Commodity Channel Index (CCI): The Commodity Channel Index (CCI) is a price momentum indicator, which measures the price excursions from the mean price as a statistical variation. It is used to detect the beginnings and endings of trends. The CCI works best on strongly up trending or down trending markets. The CCI can be used in two distinct ways:
If CCI is not viewed as a histogram, when the CCI crosses the -100 values while moving up, a buy signal is generated. When the CCI crosses the +100 value while moving down, a sell signal is generated. This is called the "Normal CCI" method.
If CCI is viewed as a histogram, when the CCI crosses the 0 value while moving up, a buy signal is generated. When the CCI crosses the 0 value while moving down, a sell signal is generated. This is called the "Zero CCI" method.
Choppyness: Choppiness is a function of market direction. A market that is trending has a low choppiness number while a trend less market has a high choppiness number. The Choppiness Index ranges between 1 and 10000, the higher the index the choppier the price action is and the lower the index the more trending the price action. The Choppiness indicator has an inverse relationship to price and a trend is considered broken when the Chop is below the lower line and reverses. Again this does not suggest one the direction of the market it just gives a fundamental different perspective on the general change of a trend. If other signals confirm that this is a turning point, it could be likely that we are headed towards a new trend direction down and it might be a good time to sell, or go short.
Demand Index: The Demand Index, developed by James Sibbet, combines price and volume in such a way that it is often a leading indicator of price change. The Demand Index calculations are too complex, however, for this text. The calculations require 21-column accounting paper to calculate manually. There are six "rules" to the Demand Index:
a) A divergence between the Demand Index and the price trend suggests an approaching weakness in price.
b) One more rally to new highs usually follows an extreme peak in the Demand Index (the Index is performing as a leading indicator).
c) Higher prices with a lower Demand Index peak usually coincides with an important top (the Index is performing as a coincidental indicator).
d) The Demand Index penetrates the level of zero indicating a change in trend (the Index is performing as a lagging indicator).
e) When the Demand Index stays near the level of zero for any period of time, a weak price movement that will not last long is indicated.
f) A large long-term divergence between prices and the Demand Index indicates a major top or bottom.
MACD(Moving Averages/Convergence Divergence): The MACD consists of an oscillator that is the difference between two Exponential (An averaging method that weights recent data more heavily (at a geometric rate) than data from the distant past.) moving averages and a moving average of that oscillator. It can be displayed as two lines representing the oscillator and its moving average or as a histogram showing the difference between the oscillator and its moving average. A buy signal is given when the MACD graph is in an oversold condition below the origin and the MACD line crosses above the signal line. A sell signal (negative breakout) is given when the MACD graph is in an overbought condition above the origin and the MACD line falls below the signal line. The important crossovers of the MACD line to the signal line occur far from the zero line (the horizontal axis). The amount of divergence between the MACD line and the signal line is important; the greater divergence, the stronger the signal.
Momentum: The interpretation of the Momentum indicator is identical to the interpretation of the Price R.O.C (see Price Rate-Of-Change). Both indicators display the rate-of-change of a security's price. The Price R.O.C. indicator displays the rate-of-change as a percentage. The Momentum indicator displays the rate-of-change as a ratio.
Money Flow Index: The Money Flow Index (MFI) attempts to measure the strength of money flowing in and out of a security. It is closely related to the Relative Strength Index (RSI); however, the Money Flow Index accounts for volume action. The RSI incorporates price action only. Money flow (not the Money Flow Index) is calculated by determining the average price for the day and then comparing this figure to the previous day's average price. If today's average price is greater, it is considered positive money flow. If today's average price is less, it is considered negative money flow. Money flow for a specific day is calculated by multiplying the average price by the volume. Positive Money Flow is the sum of the positive money flow over the specified number of periods. Negative Money Flow is the sum of the negative money flow over the specified number of periods.
Moving Averages: Moving average is a method of calculating the average value of a security's price, or indicator, over a period of time. The term "moving" implies, and rightly so, that the average changes or moves. When calculating a moving average, a mathematical analysis of the security's average value over a predetermined time period is made. As the security's price changes over time, its average price moves up or down. There are six different types of moving averages: simple (also referred to as arithmetic), exponential, time series, triangular, variable, and weighted. In addition, one calculate moving averages of the security's open, high, low, close, median price, typical price, volume, open interest, or indicator.
The only significant difference between the various types of moving averages is the weight assigned to the most recent data. Once this "weighting" scheme has been determined, it is held static over the range of calculations. The exceptions are the variable moving average and volume adjusted moving average. The variable moving average automatically adjusts its weighting based on market conditions. A variable moving average becomes more sensitive to recent data as volatility increases and less sensitive to recent data as volatility decreases. Similarly, the volume adjusted moving average automatically adjusts as the security's volume increases and decreases.
Pitchforks : Dr. Alan Andrews developed this technique of drawing a Pitchfork based upon a Median Line. Dr. Andrews' rules state that the market will do one of two things as it approaches the Median Line:
1. The market will reverse at the Median Line.
2. The market will trade through the Median Line and head for the Upper Parallel Line and then reverse.
The Pitchfork is often used to find the top of Wave 3. Wave 3 will usually end on either the Middle Line or the Upper/Lower Parallel Line.
Price Rate-Of-Change: The Price Rate-Of-Change (R.O.C.) indicator (percent method) is calculated by dividing the price change over the last x-periods by the closing price of the security x-periods ago. The result is the percentage that the security's price has changed in the last x-periods. If the security's price is higher today than x-periods ago, the R.O.C. will be a positive number. If the security's price is lower today than x-periods ago, the R.O.C. will be a negative number.
Relative Strength Index: The Relative Strength Index (RSI) is a popular oscillator used by commodity traders. It was first introduced by J. Welles Wilder in an article in Commodities (now known as Futures) magazine in June, 1978. Step-by-step instructions on calculating and interpreting the RSI are also provided in Mr. Wilder's book, New Concepts in Technical Trading Systems (see Suggested Reading).
The name "Relative Strength Index" is slightly misleading as the RSI does not compare the relative strength of two securities, but rather the internal strength of a single security. A more appropriate name might be "Internal Strength Index."
The RSI is a fairly simple formula.. The basic formula is:
RSI = 100 - [100/(1+(u/d))]
Where:
U = An average of upward price change.
D = An average of downward price change.
Regression Trend Channls: Regression Trend Channels are calculated using the actual prices of the bars in the trend. A linear regression line is calculated, and then an upper and a lower channel are drawn using a standard deviation of the regression line or by using the highest high or the lowest low of the trend. The break of a Regression Trend Channel is usually used as an entry or exit signal.
Stochastic Oscillator: Sto.chas.tic (st kas'tik) adj. 2. Math. designating a process having an infinite progression of jointly distributed random variables.-- Webster's. The Stochastic Oscillator compares where a security's price closed relative to its trading range over the last x-time periods. The Stochastic is designed to indicate when the market is overbought or oversold. It is based on the premise that when a market's price increases, the closing prices tend to move toward the daily highs and, conversely, when a market's price decreases, the closing prices move toward the daily lows. A Stochastic displays two lines, %K and %D. %K is calculated by finding the highest and lowest point in a trading period and then finding where the current close is in relation to that trading range. %K is then smoothed with a moving average. %D is a moving average of %K.
Support and Resistance: Support is the price level at which demand for a script is expected to be strong enough to prevent the price from sliding further. Or in simple words, it is that level from where the price is expected to rise up wards. Resistance is that level of price where selling pressure is expected to accumulate to restrict the price to climb beyond. In other words, it is that level of price wherefrom the price is expected to decline. Support and Resistance are imaginary subjective levels and vary according to the mode of trading/investment. For example, for one trading on 5 minute chart cannot have same support and resistance level of the one trading at end of the day platform. Support/Resistance levels are normally drawn based on important highs and lows experienced in the past. Apart from above, support/resistance levels drawn based on Gann Angles, Fibonacci Arc, retracements levels, etc work excellently.
Trend lines: Technical analysis evolves around price trends. A trend line is a straight line connecting two or more price points and then extending in to future to act as a line of support or resistance. Up trend line has, quite naturally, a positive slope whereas the down trend line is seen with a negative slope.
Types of Price Plots: There are nine ways to view the pricing information: candlesticks, candle volume, equivolume, kagi, high/low/close bars, line, point & figure, renko, and three line break. The most common style of price plot is the high/low/close bar.
Line charts require only closing prices to plot, whereas Candlesticks require all four pieces of pricing information--open, high, low, and close. And as their names imply, Equivolume and Candle volume incorporate volume into the price plot.
Certain line studies (i.e., cycle lines, Gann grids, and Fibonacci Time Zones) plot unevenly on equivolume and candle volume charts. This is because the distance between time periods on these charts varies. The same line studies, when plotted on kagi, point & figure, renko, and three lines break charts; also produce results inconsistent with normal interpretation.
Indicators calculated on kagi, point & figure, renko, and three line break charts use all the data in each column and then display the average value of the indicator for that column.
Volume: Volume is the number of units (i.e., shares or contracts) traded during a specific time period. The analysis of volume is a basic yet very important element of technical analysis. Volume helps measure the intensity of price movement.
Often, the y-axis scale for volume is displayed in multiples of 10s or 100s rather than the actual number (i.e., 500 = 500,000 shares). If there is a scaling multiple, it will be displayed at the bottom of the y-axis scale. Volume is normally displayed in a histogram line style below the prices.
Volatility: The Volatility indicator compares the spread between a security's high and low prices. This is done by first calculating a moving average of the difference between the daily high and low prices and then calculating the percent rate-of-change of that moving average. This indicator quantifies volatility as a widening of the range between the highs and the lows (i.e., wider price swings during the day). There are two ways to interpret this measure of volatility. One method assumes that market tops are generally accompanied by increased volatility and that market bottoms are generally accompanied by decreased volatility. An opposing method (Mr. Chaikin's) assumes that an increase in the Volatility indicator over a short time period indicates that a bottom is near (e.g., a panic sell-off) and that a decrease in volatility over a longer time period indicates an approaching top (e.g., a mature bull market).
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