Portions of this article appeared in January 2009
Objective trend tools provide a view of the past, but keep you grounded as to what is actually happening in the markets. Moving averages [MAs], regression channel, and retracement levels can be augmented with subjective methods such as support/resistance and trend lines to form a rational opinion of current market conditions. An outlook also requires looking forward; creating expectations for the future while recognizing a constant stream of new data means anything can happen.
In addition to pure price action, traders and investors can use volume and momentum to assess whether trends will persist or be halted by support/resistance areas. These indicators can provide valuable confirmations and warnings. To round out an outlook, volatility, breadth and sentiment are often added to view a more complete picture.
Most technicians incorporate volume with price in their assessments, but different approaches work for different people. If you’re in the “volume matters” camp, consider adding volumes bars with a moving average to assess relative conditions and a volume based indicator. The most common application is to monitor volume as price a target area with these conclusions:
- If volume is diminishing, chances favor the support or resistance area holding, and
- If volume is increasing, chances favor a break of the support or resistance area.
Joseph Granville’s On Balance Volume [OBV] is a freely moving indicator (not range-bound) that is used as a confirming/diverging tool for price trends. A downward trend in any time frame is considered suspect if it is accompanied by diminishing volume and/or a rising OBV. An advantage to freely moving oscillators such as OBV is it can continue to improve or deteriorate in extreme markets.
There is a very wide range of momentum tools available so it’s important to avoid confirming your view with repetitive information. To minimize this potential, consider the following for your tools:
- Setting or speed and
- Range in which the indicator can move
Two readily available tools which vary construction and range include:
- Relative Strength Index [RSI] from Welles Wilder and
- Moving Average Convergence-Divergence [MACD] from Gerald Appel
RSI is a range-bound oscillator that measures the price of an index or security against its own price x-periods ago. Applications include assessing overbought/oversold regions and confirmation/divergence of price trends.
MACD moves freely and uses lagging MAs using a leading calculation. As a result, it can be a nice complement to RSI even when similar speeds are used.
As a basic application for volume and momentum, consider the likelihood price will breakthrough a specified support/resistance target.
- When price is trending up/down ask, “Does price have enough strength to breakthrough this resistance/support area?”
- When price is moving sideways ask, “What direction seems to be favored?”
Remember that an outlook doesn’t provide you with a sure-fire roadmap to future prices; it is simply a collection of tools you can use to assess conditions and make an educated judgment about the movement in the future. It also identifies things to monitor that may change your view.
Other Tools to Consider
Volatility: Volatility is the range and speed in which prices move and can be measured on a relative basis with different tools. Examples include: VIX, ATR, Bollinger Bands, etc.
Breadth: Breadth indicators often break market data into advancing and declining pieces. Indicator trends and extreme readings are used as confirmation/non-confirmation or to identify bullish/bearish conditions. Examples include: TRIN, McClellan Oscillator, Advance/Decline Line, etc.
Sentiment: Sentiment measures attempt to assess extreme emotion in the market via trader/investors opinions and actions. Examples include: VIX, Put-Call Ratios, investor polls, fund flows, etc.
Putting it All Together
Identify the tools you consider to be primary for your outlook by focusing on your trading and/or investing style. For each primary tool, identify one or two synergistic techniques or tools rather than redundant ones.
Keep in mind your time horizon:
- If you’re performing a longer-term investment-oriented outlook you may want to complete that first, and separate from your shorter-term analysis. Remember stronger trends tend to be more apparent using longer-term charts and slower indicator settings.
- While a longer-term trend is considered stronger, short and intermediate-term trends can have staying power too. Expect to see both bullish and bearish trends develop in the short-term and intermediate-term before the long-term trend changes. This means that even if you’re a longer term investor you may need to look at a relatively shorter view to get your bearings on what’s happening in the markets … especially if you’re exposed to media blasts of market activity.
Consider whether you can identify objective price-MA positions that are best suited to your style by looking back at your performance. Such observations may simply represent one piece of data for your outlook. Keep in mind that a basic tool is not equivalent to one that’s substandard. Sometimes a straightforward tool is what’s needed to get on solid footing
Before you start exploring a “want to know this indicator better” list, construct charts with your primary tools and start monitoring them. Recognize there is no Holy Grail combination guaranteeing future market direction, so your job is to objectively assess current conditions and weight scenarios going forward. This is accomplished with an intentional approach.
As a last comment, don’t underestimate the importance of finding the approach that is bested suited to you to most effectively manage your emotions. Trader psychology challenges are thriving in all of us.
Resources to Consider
Gilbert Raff, Trading the Regression Channel, Stocks & Commodities, V 9:10 (403-408).
Wilder, J.W. (1978). New Concepts in Technical Trading Systems. Winston-Salem, NC: Hunter Publishing Company.
RSI: Clare White, CMT, Analytical Toolbox: Cardwell Techniques with the RSI & Analytical Toolbox: Speaking with Andrew Cardwell Parts 1 & 2 ”, Optionetics.com, July 2008.
MACD: Appel, G. (2005) Technical Analysis: Power Tools for Active Investors. Upper Saddle River, NJ: Prentice-Hall, Inc.
Price Action and Volatility
Bollinger, J. CFA, CMT (2002). Bollinger on Bollinger Bands. New York, NY: The McGraw-Hill Companies.
Fontanills, G.A. & Gentile, T. (2003). The Volatility Course. Hoboken, NJ: John Wiley& Sons, Inc.
Morris, G. (2005). The Complete Guide to Market Breadth Indicators. New York, NY: The McGraw-Hill Companies.
Colby, R. W. CMT (2002). The Encyclopedia of Technical Indicators. New York, NY: The McGraw-Hill Companies.
Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
Questions for Clare? Please visit the discussion board on the homepage of Optionetics.com.