Technical indicators

Moving Average

We use a 21 day simple moving average in our index trading system. To calculate this moving average we simply add up together the 21 days and divide by 21 and we do so for each day. We tried several moving averages and this one is the best.

Trading Bands

We use an Upper Band and a Lower Band. A trading band is simply an offset from the moving average. For example if we want a 3% upper band, we will simply multiply the moving average for the same day by 1.03. On the other hand if we want a 3% lower band we will multiply the moving average by .97. Those bands are important. As you can see on a graphic an index tends to stay inside those bands most of the time(90%) and by selecting the right band size we can handle very well the volatility of each index. For each of 3 indexes we cover in our index trading system we calculate the values for both Upper and Lower Bands based on the each index market movement. For example with the Nasdaq 100 the volatility went from 2% up to 7% and now in 2005 it is back to 3% not much more than SP500 at 2.1%.

Here is a graphic example.

We use 2 trading technical indicators in our method. We use the Relative Strength Index (RSI) which is the mostly reliable indicator. We use a 14 day RSI and it is automatically calculated in our software program, you don't have to worry about calculations for this indicator.

We also use our proprietary Momentum technical indicator. This indicator is very simple to calculate and it is also calculated automatically by our software program. This indicator indicates better how volatile is an index compared to another. We will see later how we use it a lot in our index trading system. The momentum moves is used to calculate the volatility of each market over a 7 months period and is then directly used to calculate the band size (Lower and Upper band)

Click here to see the example

Relative Strength Index (RSI)

This technical indicator is displayed on a scale between 0 and 100. 0 indicates a very weak market and 100 indicates a very strong market. With this technical indicator we look for 30 and 70. 30 means we have what we call an Oversold market and in many circumstances we have a buying opportunity. On the other hand 70 means we have an Overbought market and we can expect the market to set back either a little or take a slump for a while. Of course it is not that simple with this technical indicator but with indexes like SP500 and ND100 using that 30 or below level will give you excellent buying point. We cannot say the same thing however with individual stocks.

Click here to see the example

Momentum indicator

This proprietary technnical indicator oscillates between negative numbers and positives numbers. On the graphic you will see a solid line at 0 level all across the screen. The momentum displays itself on each side of that zero line. If the momentum technical indicator shows a very negative number we can say that the market is oversold and on the other hand we can say that the market is overbought. The oversold and overbought levels are not the same on each market contrary to the RSI. Because this technical indicator carries in itself a volatility indication, then the numbers varies from one market to another. For example we can see that oversold levels starts at 2.2 times the band size of any index market. So the value won't be the same for each market. This is a major advantage of this indicator compared to the RSI. We will use this indicator a lot in our index trading system.

Basics on technical Analysis

So far we have seen description of some technical indicators. Now let's see how we can combine all of that to analyze market behaviors.

Locate where the market stands at any given day.

On the graphic display find out if the market is near the lower band or the upper band or around the moving average. If the market is at the lower band we might have a fair buying opportunity even if technical indicators are not fully oversold.

On the other hand if we touch the upper band and we enter a bad period of the year(march-april, august-september) we will have to be careful. It does not mean that you must sell right there but you will have to take in considerations other factors like how far are we in our intermediate cycle (discussed later), are we in presence of a double top, etc.

Observe the oversold overbought levels

To do this you need to check the technical indicators values. We discussed earlier how to spot oversold and overbought conditions. We don't want to buy if the RSI is at around 70. We would rather buy at around 30. We will also check if we are close to oversold levels and for how long was the market falling. We can also check if the price we observe at that point is lower or higher than the previous significant low.

Divergence checking

A divergence is a very powerful situation in technical analysis. To check for a divergence we must first find out a previous significant low. Second if the market we analyze comes back near that point after moving up from that previous significant low in a period of 12 days or more. Third we check the value of technical indicators on both points. Fourth if the technical indicator reading for the second point is higher than the first one we have a divergence and this condition is the most powerful buying opportunity you can find and it presents itself at least once a year and it always presents itself to spot the end of a bear market. Take a look a gain on SP500 market between end of august 1998 and mid-October 1998 how a divergence condition triggered a 20% market move.

Here is a graphical example

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