Bands. Note in Figure 2.3 how price tends to reverse direction after reaching either the upper or lower Band.

Volume Accumulation/Distribution (V-A/D)

It is generally accepted in technical analysis that volume leads price. When a stock breaks out of a consolidation pattern on increasing volume, for example, it is considered a valid breakout and the expectation is that price will move higher. However, if a breakout is followed by lethargic volume, it is considered suspect. Therefore, an issues current volume relative to its recent volume can be highly useful not only in assessing the viability of an issues current trend, but also the likelihood of a change in price direction.

One indicator that can prove helpful in depicting the price-volume relationship is called Volume Accumulation/Distribution. Developed by Marc Chaikin and based on earlier work by Larry Williams, the indicator is calculated by adding (or subtracting) a percentage of the periods volume to a cumulative total. The percentage is determined by the relationship among the days high, low, and close. When the close is nearer the high, a larger percentage of volume is added, and when the close is nearer the low, a larger percentage of the volume is subtracted. A close exactly at the midpoint of the days range would cause the indicator to be unchanged (see Figure 2.4).

Because it is a summation indicator, the actual values will depend on the number of periods under consideration. However, the actual value is of little importance; it is the direction of the indicator line that matters. If the line is pointing up, the stock is considered to be under accumulation, and the steeper the line the greater the buying

Figure 2.4 Volume bars and the volume accumulation line.

pressure. If it is pointing down, it is considered to be under distribution, and the steeper the slope the greater the selling pressure. A buy signal is generated when the indicator line turns from down to up, and a sell signal is just the opposite. Also, divergences from price direction and/or nonconfirmations of new highs or lows can be a significant early warning of an impending change in price trend. The only variable parameter in the calculation of Volume Accumulation/Distribution is the number of periods under consideration.

Commodity Channel Index (CCI)

Many technicians believe that markets (e.g., stocks, funds, commodities) move in waves or recognizable patterns over time. And whether attributable to naturally occurring events (the normal business cycle, presidential election campaigns, the planting/harvesting sequence of certain commodity crops, etc.) or a more cosmic phenomenon (the alignment of the earth and stars or gravitational forces), markets do appear to have some cyclical appearance. Notice, for example, Figure 2.5 shows the recurring cycle peaks in the following weekly chart of the S&P 500 Index from 1970 to 1995.

The technicians task, then, is to determine the extent to which an issue is exhibiting cyclical behavior, and to take advantage of those cycles that are the most reliable or tradable. One indicator that was designed to do just that is the Commodity Channel Index, published by Don Lambert in 1980. The CCI evaluates how the current typical price deviates from the mean typical price to determine when issues are

figure 2.5 price cyclicality. the s&p 500 has visible price cycles whose peaks are marked by arrows.

01-1970

fSPX) S&P 500

05-1995

Price Cyclically

* 4. ,..........f

..............r"4,, .....,..............................

i J 4 /«...... 1

V"

ifl1

70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 ffi

-525.00 500.00 475.00 450.00 425.00 400.00 375.00 350.00 325.00 -300.00 275.00 25000 1-225.00 200.00 175.00 150.00 125.00 100.00 75.00

near the tops or bottoms of their cycles. It differs from other cyclical indicators, though, in that its calculation is based on a mean deviation rather than a standard deviation. Although originally developed for use with commodities (thus its name), the Commodity Channel Index may be used equally well with stocks, funds, indexes, and so on (see Figure 2.6).

The CCI is designed to oscillate in a range of between +100 and -100, which captures 70 percent to 80 percent of random price fluctuations, and within which the issue is considered to be exhibiting normal price cyclically. When it moves outside this range, it signals that price may have begun trending. Trading rules as originally advanced by Lambert were:

• Buy long when the indicator breaks above +100, and sell long when it breaks back below+100.

• Sell short when the indicator falls below -100 and cover short when it breaks back above -100.

This approach however, is very short term, and tends to leave the trader on the sidelines most of the time. A better approach may be to buy long (cover shorts) when the CCI breaks above -100 moving up, and selling long (enter shorts) when the CCI breaks below +100 moving down. The CCI has one variable parameter, which is the number of periods over which the calculation is made.

Figure 2.6 Commodity channel index. An example of the CCI line.

Commodity Channel Index

4 11 18 251 8 1522296 13 20 *27 3 10172431 7 1421285 1219262 9 16 ;

-150.00 125.00 100.00 75.00 50.00 25.00 0.00

(-25.00 50.00 75.00 100.00 125.00 150.00

-175.00 200.00