Transcript Fundamental of Technical Analysis and Algorithmic Trading

Doğu Akdeniz Üniversitesi
Faculty of Business and Economics
Department of Banking and Finance
Saeed Ebrahimijam
FINA417
Spring 2013
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Momentum oscillator concept (review)
RSI history
What is Relative Strength Index
How to calculate RSI
Overbought vs. Oversold
Failure swing in RSI
RSI Interpretation for trading
Polarized fractal efficiency Index(PFE)
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Momentum is the rate of the rise or fall in
price.
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The Relative Strength Index (RSI) is a price
momentum indicator
By: Welles Wilder
published in a 1978
book, New Concepts in Technical Trading Systems
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and Algorithmic Trading
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Particularly those who are commodities and
futures oriented.
The RSI is frequently confused with relative
strength
analysis,
which
compares
the
performance of two items (e.g., one stock with
another or one stock with an overall market
index). Don’t make mistake!!!!
It is intended to chart the current and historical
strength or weakness of a stock or market based
on the closing prices of a recent trading period.
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RSI is a rate-of-change oscillator.
It measures the velocity at which prices are moving.
RSI was intentionally designed to address three
flaws often associated with oscillators.
First, at times, oscillators move erratically because of the drop off of old
data in their calculation. For example, if one has a 10-day oscillator and
10 days ago the price of the security moved up or down dramatically,
the current oscillator reading will be a misleading low or high reading.
A second problem relates to the vertical scale for an oscillator. How high
or low should the oscillator be so that it will signal buying or selling
opportunities?
The third and final problem is the need to keep massive amounts of data
for oscillator calculations.
RSI presents a solution to these problems.
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RSI is calculated as follows:
The RSI ranges from 0% to 100 %.
The RSI is presented on a graph above or below the
price chart.
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To get the average up value, add the total
points gained on up days during the last 14
days and divide by 14.
The average down value is arrived at by
adding the total points lost on down days
during the last 14 days and dividing by 14.
Divide the average up value by the average
down value to calculate the relative strength
(RS).
Insert the RS value into the formula and
calculate the first day’s RSI value.
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Simply multiply the previous up and down
average values by 13, add the latest day’s
gain or loss to the up or down average, and
multiply the total by 14.
Insert the new RS value into the RSI formula
and recalculate the RSI.
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Wilder suggests the use of 14 days of data in the
RSI calculation; however, other technicians have
found that other time periods work with success
as well.
The greater the number of periods used, the
more stable the RSI is, and the fewer signals are
generated.
Short-term RSIs tend to produce more signals
than longer-term RSIs, including more false
signals.
Figure 15-1 compares RSIs of differing lengths—9 and 14
days—for the S&P 500 index. Note the difference in the
number of crossings of the 70 and 30 lines.
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Shorter or longer timeframes are used for
alternately shorter or longer outlooks.
More extreme high and low levels—80 and
20, or 90 and 10—occur less frequently but
indicate stronger momentum.
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The RSI can be interpreted from the following
five perspectives:
1.
2.
3.
4.
5.
Extreme readings.
Chart patterns.
Failure swings.
Support and resistance.
Divergence.
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Extreme RSI readings signal the likelihood of
major tops or bottoms.
Although the exact levels to use are subject
to debate, Wilder recommends using levels of
70 and 30.
- If the RSI rises above 70, a major top in
market prices is likely.
- A decline to below 30 suggests a high
probability of a major bottom being made.
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An asset is deemed to be overbought once the
RSI approaches the 70 level, meaning that it may
be getting overvalued and is a good candidate
for a pullback.
Likewise, if the RSI approaches 30, it is an
indication that the asset may be getting oversold
and therefore likely to become undervalued.
- It’s generally better to buy a market when it’s
oversold and sell when it’s overbought
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The chart patterns presented in Lessons 3
through 5 are equally applicable to RSI as
they are to regular price charts.
Often, chart patterns (such as a triangle or
head-and shoulders top or bottom) can be
seen in the RSI.
Since the same breakout rules apply to the
RSI as to normal price charts, buy and sell
points are frequently indicated.
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Failure swings can also be used in interpretation
of the RSI.
what a failure swing is?
- As illustrated in Figure 15-2, a top failure swing occurs
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when the index rises above 70, declines to a
lower level (fail point), rises again but fails to
reach the 70 level, and then falls below the prior
lower level (a fail point). One would sell at that
point.
Figure 15-3 illustrates a bottom failure swing. It
is simply the opposite of a top failure swing.
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Even one step further is the failure swing, a
term that Wilder uses to refer to "very strong
indications of a market reversal."
Wilder uses failure swings to confirm his buy
and sell points, and in the two figures below
you can see that failure-swing points clearly
do just that.
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Wilder thought that "failure swings" above 70 and
below 30 on the RSI are strong indications of market
reversals.
The center line for the relative strength index is 50,
which is often seen as both the support and
resistance line for the indicator:
- If the relative strength index is below 50, it
generally means that the stock's losses are greater
than the gains.
- When the relative strength index is above 50, it
generally means that the gains are greater than the
losses.
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Support and resistance lines will often be
apparent on the RSI before they are apparent
on the bar chart of prices.
Breaking of support or resistance is
interpreted in a similar fashion to the
interpretation of price charts.
Refer to chapter 7 on support and resistance for a refresher.
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Divergence between prices on a bar chart and
the RSI strongly suggests that prices will be
reversing.
If prices are rising or flat and the RSI is
decreasing, look for a turn downward in
prices.
If, on the other hand, prices are declining or
fl at and the RSI is increasing, expect prices
to turn and move higher.
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Hans Hannula presented his PFE indicator in
1994 issue of Technical Analysis of Stocks &
Commodities magazine.
http://www.traders.com/index.php/sac-magazine
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This indicator is intended to portray the laws
of "fractal geometry" in the form of an
oscillator.
It is better to use it on price diagram.
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The formula is very complex. A description of this
formula in words might be confusing.
The PFE is calculated of the Exponential Moving Average
(EMA) of Effizent:
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The Polarized Fractal Efficiency indicator uses
fractal geometry to determine how efficiently
the price is moving.
http://finmind.blogspot.com/2005/08/william-eckhardt-c-test.html
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The adjustable period length can be chosen
from 2 to 500. The most common settings
will have a period length ranging from 8 to
30.
Use 14 days period of calculation.
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The more linear and efficient price movement, the shorter
the distance the prices must travel between two points.
The more "squiggly" the price movement, the less efficient
it's travel.
1- The permissible values for PFE lie in the range between
+100 and -100. Whilst a crossing of the zero line may be
interpreted as a warning of an impending trend change,
only values over +40 / +60 are usually regarded as a buy
signal and those below -40 / -60 as a sell signal.
2- When the PFE is zigzagging around zero, then the price is
congested and not trending. When the PFE is smooth and
above/below zero, then the price is in an up/down trend.
The higher/lower the PFE value, the stronger the trend is.
http://www.amibroker.com/library/list.php
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The strength of the trend is measured by the position
of the PFE relative to the zero line. As a general rule,
the further the PFE value is away from zero, the
stronger and more efficient the given trend is. A PFE
value that fluctuates around the zero line could
indicate that the supply and demand for the
security are in balance and price may trade sideways.
Simple decision making of trading policy:
Find maximum and minimum points on PFE diagram:
- Max points are appropriate time for Sell.
- Min points are appropriate time for Buy.
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Install a PFE indicator on your Metatrader
software and find the PFE index on EURUSD
price ratio. Then Interpret your findings.
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and Algorithmic Trading
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