Chapter 7 - Quantitative Analysis (Done) Flashcards

Question

Explain the concept of momentum and rate of change.

Answer 1

* The momentum indicator measures the difference between the price today and the price some number of periods ago. The rate of change indicator measures the percentage change in price from a previous period to today. * While mainly used to identify divergence between a security’s price and its momentum, these indicators can also be used to generate buy and sell signals.

Answer 2

* The stochastic measures, on a percentage basis, where the most recent close is relative to the overall price range across a given timeframe. * Stochastics quantify a market’s tendency to close near the upper end of the range in an uptrend, or near the lower end of the range in a downtrend. * Stochastics consist of two plots: a %K line and a %D line. * The %K line measures the momentum of the security or market; the %D is a moving average of the %K. * Stochastics can be used to generate buy and sell signals through identification of crossover points between the %K and %D lines.

Answer 3

* The RSI measures, over a certain number of periods, the relative strength of price gains on up days to the price losses on down days. * Like the other momentum indicators, the RSI can be used on its own for buy or sell signals, or in identifying divergences.

Answer 4

* Two other popular momentum indicators similar to stochastics are the Williams %R and the Commodity Channel Index (CCI). * The Money Flow Index is a volume-related oscillator.

Answer 5

Divergence generally means two things are moving apart while convergence implies that two forces are moving together. In the world of economics, finance, and trading, divergence and convergence are terms used to describe the directional relationship of two trends, prices, or indicators.

Answer 6

A Bollinger Band consists of a middle band (which is a moving average) and an upper and lower band. These upper and lower bands are set above and below the moving average by a certain number of standard deviations of price, thus incorporating volatility.

Answer 7

"A week's trading range" refers to the difference between the highest and lowest prices at which a stock, commodity, or other financial instrument was traded over a week. It shows how much the price fluctuated during that period.

Answer 8

A range-bound market is one in which price bounces between a specific high price and a low price. The high price acts as a major resistance level in which price can't seem to break through. Likewise, the low price acts as a major support level in which price can't seem to break as well.

Answer 9

VWAP is the average price of a stock weighted by volume. By monitoring VWAP, a trader might get an idea of a stock's liquidity and the price buyers and sellers agree is fair at a specific time. The VWAP indicator can be used by day traders to monitor intraday price movement. VWAP, or Volume Weighted Average Price, is a trading benchmark that calculates the average price of a stock based on how many shares are traded at different prices throughout the day. Essentially, it means that higher volume trades at certain prices have more influence on the average price calculation than lower volume trades at other prices. This way, the average price reflects where most of the money was transacted during the day. Essentially, VWAP is a measure of fair value. Fair value is the reasonable and unbiased price at which an asset, like a stock, would be bought or sold in a normal market condition. It represents a price that is agreed upon by both the buyer and seller, assuming both have adequate information and neither is under any pressure to trade. Therefore, trading above VWAP can suggest that a security is overvalued, while trading below VWAP can suggest that a security is undervalued.

Answer 10

Anchored VWAP is a variation of the standard VWAP that starts the average price calculation from a specific point in time, like a significant market event, rather than the beginning of the trading day. This allows traders to measure the average price based on the volume from that specific event onward, providing insights tailored to particular market movements or periods. You set where you want the VWAP measurement to start from. That is the difference between VWAP and anchored VWAP.

Answer 11

1. if the market is trending and which direction the trend is (trend-following indicators); 2. the strength or weakness of the trend (momentum indicators); and 3. whether or not the market is overbought or oversold (contrary indicators).

Answer 12

* The moving average direction changes in favour of the new developing trend. * The moving average is of significant enough length. A crossover of a short-term moving average does not have any significance with respect to a long-term trend. * The moving average, through historical testing, is found to be significant for that particular market. For example the 200-day, or 40-week, moving average is considered a very key moving average for equities. Moving averages of different lengths may be found to be more suitable for other markets. * The crossover (price track crossing the moving average) is supported by the chart action such as breaking of a trendline or confirmation of a reversal formation.

Answer 13

* difference between today’s high and low (or the high and low for whatever timeframe is being analyzed); * difference (absolute value) between the prior close and the current high; or * difference (absolute value) between the prior close and the current low. The Average True Range (ATR) is another volatility indicator, but this focuses on the range of price activity, not the underlying trend. The ATR is an average (typically, 14-day) of the True Range.

Answer 14

The directional movement index (DMI) can be used as both a filter to determine whether or not a market is trending, or on its own as a trend-following system that generates buy and sell signals. The DMI indicator was created by Welles Wilder in his book New Concepts in Technical Trading. As a filter, the DMI indicator produces what is referred to as the ADXR line that is plotted between 0 to 100. When the line is over a certain level (25 is used for most markets) and moving higher, the market is considered to be trending. Traders can then use a trend-following system, such as Bollinger Bands, to pick entry and exit points. When the line is under 25, the market is considered to be non-trending. Traders should either ignore this type of market or use a trading system that is designed to take advantage of a sideways market, such as oscillators (covered below) or the range-bound application of Bollinger Bands. The DMI indicator can also be used as a trend-following system. Buy signals are given when the +DI line, which measures upward movement, crosses over the –DI line (which measures downward movement). Sell signals are given when the –DI line crosses the +DI line. The signals are valid when the ADXR line is suggesting the market is in trending mode. For the purpose of this course, readers should understand how the ADXR, +DI and –DI lines are used. Those interested in learning more about the indicator are directed to the Wilder text.

Answer 15

The stochastic indicator produces two lines, the faster %K and the slower %D, which both fluctuate between 0 and 100. Stochastics are used to generate buy and sell signals based on crossovers, to identify overbought and oversold levels and to conduct divergence analysis. Buy or sell signals are given when the %K crosses the %D. Buy signals are set up when, during a market correction, prices decline to the point where the %K line falls under 20, which is considered an oversold level. When the %K then crosses back over the %D line (from below) the buy signal is generated (see Figure 7.12). The signal is even more effective when a bullish divergence is evident, that is, when new lows in prices are not confirmed by the %K or %D line. Because the stochastic is measuring a shift in market direction, protective stops should be placed below the lows/highs of the bar where the shift occurred. Figure 7.12 shows several buy signals for Barrick Gold generated when the %K crossed over the %D following a market correction which saw the %K line fall under 20. Sell signals are the exact opposite, set up when the %K line climbs over 80 (overbought). Another way to use stochastics is as an overbought/oversold indicator. However, these terms can be misleading in a trending environment when discussing the stochastic indicator. With typical overbought levels at 80 or higher and typical oversold levels at 20 or lower, a reading of 80 just tells us the security is closing within the top 20% of its high and low range for the period being analyzed. Just because a market is “overbought” does not mean it should be sold; in fact, an overbought condition, as defined by the stochastic indicator, means that the market is regularly closing strongly in a trending market, which is certainly not bearish. Oscillators can and will remain for extended periods in overbought or oversold territory. Remember, they are designed to work best in periods of sideways price action, not strongly trending markets. The best way to use stochastics is as a buy signal after a price correction (decline) in a bull market or as a sell signal after a rally in a bear market, when the indicators reach oversold or overbought levels and the crossover occurs.

Answer 16

Similar to the stochastic, the RSI also has overbought and oversold levels. The standard ranges are above 70 and below 30, which act as warning signals of overbought and oversold conditions respectively. Some markets by their nature will rarely reach these extremes. A reading of 80 tells us that the market is closing, on average, four times stronger on up days than it is closing weaker on down days during the time period analyzed. A 14-day RSI reading of 80 is very strong. When a market remains above or below 50 for extended periods of time, it is generally considered to be trending (see Figure 7.13).

Answer 17

Technical analysts will often use two moving averages, one shorter-term and one longer-term. Buy and sell signals are given when the shorter-term average crosses the longer-term average (see Figure 7.3). This method of using moving averages can be effective, since in essence the price data is being smoothed twice, which reduces the chances of false signals. The key to using two moving averages, as it is with using one, is to find the moving average length that works best for the particular security or market being analyzed.

Answer 18

Short-term moving averages are more sensitive to daily price changes because they average prices over a shorter period. This means they react more quickly to recent price fluctuations, often resulting in frequent crossings over the stock price line. These frequent crossings can generate multiple trading signals in a short period, increasing the likelihood of entering or exiting trades prematurely or unnecessarily, which is often referred to as getting "whipsawed."

Answer 19

CROSSOVERS The basic MACD signal is given on crossovers between the MACD line (the difference between the 12- and 26-day moving averages) and the signal line (the smoothed moving average of the MACD line). Buy signals are given when the MACD line crosses above the signal line; sell signals are given when the MACD line crosses below the signal line. DIVERGENCES The concept of trend analysis and the making of higher highs and higher lows are at the root of divergence analysis. The concept of confirmation also runs deeply throughout technical analysis, and is very important in momentum analysis. Consider a rubber ball that has been dropped; each successive bounce has less and less momentum. For confirmation of a strong uptrend, it is important that the quality of momentum increases as the market moves higher. If a market is rallying with less and less momentum, it is a sign that the strength of the market is changing. Divergence analysis is a very powerful technique for identifying this change. While a divergence signal is not enough in itself to buy/sell a security, it does flash warning signs that a change in trend is possible. Figure 7.7 shows MACD divergences on a daily chart. This is a very good indicator for tracking trend changes in assets with high volume, broad participation and normal volatility, such as blue chip stocks, government bonds and stock indexes.

Answer 20

Combining several time periods is helpful in spotting when cycles of various time frames peak and trough, and can add a very valuable piece to the analysis process. Though not specifically recommended for trading, it can help establish the significance of a market extreme point. Figure 7.11 shows a 3-, 6- and 12-month ROC for a stock. Note that the coincidence of the cycle low periods identified a key longer-term turning point in the market (August 1993). The crucial element in spotting key cycle low points is to ensure that the cycle is near a historical extreme for all time frames.

Answer 21

RVOL is calculated by comparing the current trading volume of a stock to its average trading volume over a given period of time.