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Source Chart created with TrodeStotion" by Omega Research. Ir

responding forecast (trendline) price can be calculated as a and irtated Ai- : mnmenium indicator .v./; This oscillator is not bounded- howtrver. by giving the \alut- a-a peri;entj)j;e, there will be more consistency over very long test periods

. = 100 >

tor practical purposes, a 3-period smoothing ol "-cF ntr, more cc)nsistenc\ \X1jtn oF = then the- trendline and prices are moving parallel to one another, when "oF > i) the market is -lerating away from the trendline; and when < 0. pnces are sUminn down and the two beries are converging. Traders interested in this technique should also read the section on acceler;

An Oscillator to Distinguish between Trending and Sideways Markets

rhe lack of predictability of trending markets is the greatest problem for the anal\"st I he worli fouiwl under the topics "I3ireciioiial Movement" and RankinB" in Chapter 2 i Kisk t (introl") this hook discusses that isbue Based on the ide that tiic trnd component is stronger when price is farther from fair value, and the noise (.sidewayb moiememi is greater when price is near value, an oscillator can be created to show tlie strength of the trend component basetl on thts concept.

Strength Oscillator =

gavafclt>s

avgfhighH, - low„,j„, n)

As the trend increases, the average cliange m closin iiriies becomes larger relatne t<) the high-low range for the day In an unusual period, when the- market gaps open, it v. on Id be possftilc for the closes to become latter than the daily range In a sidewa\s market both the

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change in the closes and daily range will get smaller, but the net price change over the period n should be close to zero This oscillator can be smoothed by taking the change in price over 2 or 3 dajs, rather ttian the most recent day, as well as the high-low range over the same number of days.

ADDING VOLUME TO MOMENTUM

A momentum indicator can also incorporate volume by multipljing the price change over n periods by the total volume over that same period. The use of a cumulative period will help to stabilize the volume, which is often erratic Although the sum of the volume over the period can be used, the average will appear more familiar and can be plotted

i volume chart. In standard and programming notation, that gives the momentum times the volume M\ as: volumcj

AfV= (price, - price „) x---

MV = (close - close[n])*@Average(volume,n)

Alternately, the price change of n periods could have been divided by n to give a per-unit value. This section will include those techniques that combine price change and volume: for methods that do not use price, see Chapter 10 ("Volume, Open Interest, and Breadth-).

Scaling by a Percentage or Volatility

The same conversions can be applied to momentum with and without volume. Using a percentage, rather than price, will add some robustness over long test periods. Because volatility often increases when prices rise faster than the percentage would show, momentum can be scaled according to a shorter measure of true range. If the true range is averaged over 20 to 65 dajs, approximately one month to one quarter, then the 1-day change in price will become a relative momentum value. By using a much longer period for averaging the true range, you can create a stable profile of the volatility changes in the underljing market.

(Percentage momentum with volume)

XMV = (close - close[nI) / closeln] * ©Average(volume.n) (Momentum with volume scaled by true range)

TRMV - (close - closeln]) / @Average(@TrueFlarge.p)1 * §fiverage(volume,n

where ©TrueRange is always calculated for the most recent period, and

@Average{@TruGRangG,p)J is the average of the 1 1 true range for the past/> days.

Volume-Weighted RSI

In the same way that the RSI adds the positive days and divides by the sum of the negative days, it is possible to weight each day by its volume to add another factor, called money flow," to the calculation. A positive or upward day is when the average of todays high, low, and close (high + low + close/3) is greater than the previous average Each average is then multiplied by the volume, giving the daily money flow, and a ratio of the past 14 days is used to create a money ratio and finally a money flow index, both stqas similar to Wilders RSI.

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-1- low + t-lose

Money Flow = volume x----------

positive money flovC*

Money Ratio =-\, . - ---

14-(Jay nt-gaiivt- montry fltiw

Money Flow Index = lOO ------

1 + Money Ratio

Herrick Payoff Index

LJsing the ehanf-e in the underlylne value of the fuirures contract, rather than only the change in price, the Herrick Payoff Index (I1PI>- combines volume and oi>en interest to l-enerate an jnclicator that, as the basic momentum calculation, is not bounded but scaled clown to a manageable vaiiie and smoothed usin(; a . 1 smoothing factor, £ (about 19 days). The daily value is

I wax \0/. 0/. \\

\Af,

and the index is an exponential smoothing of the individual daily calculations:

HP1.„ = I IPW.„„, + * X (HPl, - HPIp„„>

where ( is today

( - 1 is the previous day

cfis the conversion factor (value ofa basis point move) V, is todays volume

<jW, AJ, ,> is the difference in the mean prices low I I (vertical bars> are for absolute value

\OI, - OI, - . I is the absolute value <jf the change in open interest min<OA. OI, i) is the smaller of today and the previous open interest f IS a smoothing constant (default 1U> The expression that divides the change in mean prices by the absolute value «» the same change is used to create a -H or -1 value. This complex formula can also be written jn programming code as

HP - OBIgPclrtValue * volume * <(high-Iow)/Z - <higUL1D- 1 owl1J)/2) * <1 - {({hngh-low)/Z Ch1gh[n lowCi:)/Z> / ©Abs(<hngh low)/? (highC n - lowC 1 J )/2 ) )* Z * (@Abs<t>plnt opintri]) /@Lowes t < opi nt ,2 ) ) )

Most analjsts who use the Herd Payoff Index dTVide the HPI by 100,000 to reduce the value to a more useable level. The final series, when seen along with prices, may appear volatile and require an interpretation using trendline This is due to the fluctuations in volume and open interest, which are smoothed over 20 days, rather than longer. The HPI may be helpful, despite the volatility, because it is a combination of factors not included in most other indices, it will have pattems that appear to lead price change to compensate for maricet noise.

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Comments on the Use of Volume

Volume is an important piece of infonnation, but it can be difficult to interpret. It fluctuates in a much larger range than price, and may be one-third higher or lower from day to day. Although it indicates maricet interest and potential volatility, there are many dajs for which a high or low volume does not have a consistent reaction.

In general, adding volume to an indicatcr will result in a more volatile, erratic series. Therefore, the first steps in using volume would be

1. Create a long-term smoothed volume series.

2. Compare current volume for extremes to identify only those exceptional dajs that should be followed by high volatility.

3. Low volume should not be determined by a single day, but by either a few unusually low days together or by a volume decay over a modest time period.

VELCQTY AND ACCELERATION