The stochastic recognizes that in an uptrending market the close tends to be near high, while in a downtrending market, the close is near the lows of the time period. Using the above formula, a "raw" stochastic is found.
A three—day moving average of the "raw" stochastic is used by MMS, as the "raw" stochastic is very volatile, giving false signals. The three—day moving average is called the %K stochastic. A three—day moving average of the %K stochastic is called the %D, which gives a smoother momentum oscillator. This indicator will range between 100 (when the close is equal to the highest high of the last "x" periods) and 0 (when the close is equal to the lowest low of the last "x" periods).
The stochastic is used as any momentum oscillator, with directional movement, peaks, troughs, divergence, crossing between short term and long term stochastics, and crossing between %K and %D stochastics looked for in the chart.
Bollinger Bands—BB
Bollinger Bands are lines charted above and below the moving average of the closing prices. This analysis varies from other percentage band analysis because the distance of each band from the moving average is not fixed. Instead, the price channel these bands form around the moving average is flexible and determined by the user specifying a number of standard deviations.
The standard deviation is the method used to set the band width about the moving average. Bollinger used a 2% standard deviation to capture 95% of prices within the band. However a 1.5 standard deviation is commonly used for futures.
Bollinger Bands automatically narrow and widen in response to volatility — narrow in calm markets, and widen in volatile markets, making them an effective trend indicator.
Bollinger Bands are used with a simple price graph:
Prices near the lower band may signal an overbought market.
Prices near the upper band may signal an oversold market.
The bands often narrow before a sharp move in price. A narrowing of the bands indicates the start of a new trend, which is confirmed when prices break and close out of the band.
A price that breaks above the top band, followed by another that closes within, may signal a reversal and a good time to sell.
A price that breaks below the bottom band, followed by another that closes within, may signal a reversal and a good time to buy.
Example
If prices are moving in a downtrend and hit the bottom of the band, but close back in the bands, indicates that the trend will not continue to go down but sideways and then probably back up.
Bollinger Bands form an area of Support and Resistance and are used to take profits. If prices break above or below the Bands, it results in a changed Support and Resistance. Bollinger Bands do not indicate trading stops.
Directional Movement Index — DMI
The Directional Movement Index (DMI) determines the strength of any upward or downward trends present in the market. It consists of the following four lines:+DM measures upward movement in price over time. — DM measures downward movement in price over time. DX measures the overall direction of movement (whether up/down) in price over time. ADX measures the average direction of movement (up/down) in price over time. In effect it is the average
of the DX.
ADX measures the strength of the trend in the market. The higher the ADX, the stronger the trend present. This index does not measure the direction of the trend. In other words, it is quite common for the ADX to be rising while prices are falling — this indicates an increasing strength in the down trend.
All four lines are plotted on a scale from 0 to 100.
Comprehension questions
1. Where are Bollinger Bands charted?
2. What does the band width show?
3. What do Bollinger Bands signal?
4. What does the Directional Movement Index show?
Exercises
Ex. 1. Translate from English into Russian and vice versa
1. What are the momentum oscillators?
Momentum oscillators are technical indicators which measure the change in price over a given time period.
2. Where are M.O's used?
They are useful in trendless or sideways trending market, and significant when they reach extreme value:
overbought + 70/80%, oversold - 30/20%.
3. What signals do they give?
M.O's give market signals. Turn divergence between prices and momentum.
4. What is a Relative Strength Index?
Relative Strength Index (RSI) is a smoother oscillator created by taking the up average and down average instead of the difference in prices.
