INDICATORS
The Hunt For Superior Signals
Two Moving Function Hybrids
by William Rafter
Find out how to use these smooth and timely indicators.
In analyzing the markets, we frequently find
ourselves looking at data that is not quite adequate for our needs. More
often than not, the data is erratic. We want a reliable market indicator,
not an erratic one; so we usually smooth the data with a variety of tools.
This smoothness comes at a price — speed. Thus, when you find something
that is both smooth and timely, it's time to take notice. The moving slope
is one such indicator.
THE RATE OF CHANGE
Two of the common momentum indicators used by traders are the change
and rate of change (commonly referred to as ROC). The latter is really
only the former divided by price, but it has the advantage of being price-independent
— that is, by comparing the 25-day changes of two datasets, you must be
mindful that the datasets may be priced differently. By taking their rates
of change, you eliminate the price bias.
For example, compare the two panes of Figure 1. The top pane illustrates
the 25-day change of the closes of the Dow Jones Industrial Average (DJIA)
and the Standard & Poor's 500 (S&P). The price differences of the
respective indexes make comparison almost impossible. The lower pane shows
the indexes compared on the basis of their 25-day ROCs, which is considerably
more useful than the top pane.
Figure 1: CHANGE VS. RATE OF CHANGE. The top pane shows the 25-day
change of the closes of DJIA (blue) and SPX (red). The bottom pane shows
the 25-day ROC of the two indexes. Note that the comparison of the two
indexes based on ROC is more useful than just basing it on the change in
price.
Instead of taking the change between the price (say, 25 days ago
and today), take the regression line (also referred to as the least-squares
fit) of those 25 days and calculate the slope of that line. The slope is
merely the vertical change in that line from the first day to the last,
divided by the horizontal change. Do this on a moving basis and you have
the moving slope. The calculations are not difficult, as most standalone
market software products have the capability to do least-squares fits.
(Note that a two-period moving slope is identical to a one-period change.
That equality, however, will rarely exist beyond that first day.) Figure
2 illustrates the S&P 500 with the 25-day moving slope and both the
25-day ROC and 25-day relative strength index (RSI) shown for comparison.
...Continued in the September issue of Technical Analysis
of STOCKS & COMMODITIES
Excerpted from an article originally published in the September 2005
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2005, Technical Analysis, Inc.
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