Thursday, November 8, 2018

Trader Notes: A Second Line of Technical Indicators

Yes ! There are many reliable indicators as MACD and RSI !

The oscillators MACD and RSI, together with the moving averages, form the standard trifecta of a trader for the technical analysis. Because of its popularity, efficiency and simplicity, everyone, without exception, knows and uses them. So I'm not going to detail its benefits, only give some additional notes about them.

The MACD (Moving Average Convergence/Divergence) combines trend with momentum (or acceleration) of the price, and its signals are simple, we know: bull and bear crossovers, line plot above zero means trend up, plot below zero means trend down, rising histogram means buyers increasing, falling histogram means sellers increasing. 
My personal contribution: take care of the divergence of MACD-histogram with price in daily charts, because they had frequent errors if it is not used correctly. For this reason, the recognized trader Alexander Elder recommends using the EMA13 line as a confirmatory signal, verifying that its slope points in the direction of the divergence, bull or bear. In my trading, sometimes I add a second confirmation with the same MACD but in the weekly chart: verify if a MACD crossover matched with the divergence of the daily chart.

The RSI (Relative Strength Index) is also an oscillator but it gives different information than the MACD. It qualifies the situation of the stock as overbought or oversold according to the value of the indicator on a scale of 1-100. Its crossover at levels 30 and 70 are used by traders as a probable reversal. You can also used its divergence with price (I do not usually do it), but never as an indicator of the trend of a stock.

Technical indicators there are hundreds, to taste of each trader and his trading style. In my case, after having tried many of them during my years of trading, I manage a "second line" of technical indicators, which serve only as a complement to use in conjunction with the main ones, only to reinforce any bull or bear signal. Usually a good technical analysis can be done with 2 or 3 indicators, its enough. Remember, there are just indicators, not a strategy. There's no infallible or magic indicator: all of them give sometimes false signals. Select and use your favorites indicators in a multiple timeframe (making the strategic decision on the weekly chart and the tactical choices on the daily chart), in conjunction with fundamental analysis for a best trade.

Is necessary read the MACD with a confirmatory study as EMA13 (black line). This avoid false divergence signals as happen this year in Novavax chart during early July.

TTM Squeeze: a mix between Bohlinger and Keltner

Previously I should refer to two other popular indicators, which are quite similar, but give different readings. Both plot lines as an envelope around price, based on stock volatility. The Keltner Channels use a smooth exponential moving average as mid-line and the Average True Range as offset, while the Bohlinger Bands uses a simple moving average and offset with the standard deviation, which varies proportionally with the volatility. Both are useful as trend-following indicators, and its a good idea use them with a momentum oscillator as Stochastic or RSI, and the ADX to identify trading ranges.

In summary, the upper and lower bands of the Bohlinger represents overbought and oversold levels. The BB works best in ranging than in trending behavior of a stock. Take note that touch a band isn't necessary a sign of reversal, but probably a low-risk entry point. Keltner had different readings depending on stock behavior: if it's trending, a close above the upper is a bullish signal, while below the band is considered a bearish one. If it's ranging, envelope lines can be interpreted as overbought and oversold levels.

An indicator relates both: the John Carter's TTM Squeeze. The idea is very logical: when volatility increases, the Bohlinger Bands are widening and enveloping the Keltner Channel, while when the market is consolidating (period of indecision) the Bohlinger are inside the Keltner and the market is squeezing, preparing for a breakout to come.

As expected, different indicators give different entry-exit points. Compare several indicators, and define your risk-reward before your trade. The location of the stop loss is key to this.

Carter designed the use of dots across the zero line: red dots indicate that squeeze is on, so a consolidation breakout is coming. Green dots represent squeeze off, so market is trending. The trend momentum oscillator histogram is show by colors: in my configuration I use green for trend up and grey when its decreasing, and red when trend is down and grey when its decreasing. 

When the indicator is on (green) and the momentum oscillator is also green, is consider a buy signal for a trend-trader. When the indicator is on (green) and the histogram is red, is considered a sell signal. Both signals are supposed to be correct until two grey bars in a row appear. Try this interesting indicator in your favorite trading platform.

On Balance Volume (OBV), a different one

Less popular than those described above, the OBV is a trend indicator that measures the pressures of buying and selling, adding/subtracting volume on up/down days. Is simply a running total of up and down volume: when the security closes higher than the previous close, all of the day's volume is considered up-volume, and when close lower than the previous day, all of the day's volume is considered down-volume

As it uses volume in its calculations, and volume, in theory, precedes price, the OBV have truly good advantages versus others:
- A rising OBV reflects positive volume that can lead to higher prices. 
- As rising volume confirms an up or downtrend, if price movement precedes OBV, then it is consider a "non-confirm" movement.
- So, OBV breakouts normally precede price breakouts
An OBV ranging is an undecided trend: better hold until the trend changes.
- OBV are also useful for anticipate trend reversals, using its bullish/bearish divergences with price.
- Be careful when volume spikes: it usually throw off the indicator at that point.

OBV divergences are infrequently but powerful signals. Always use in conjunction with another indicators, as an oscillator. This ADP chart show three of OBV features.