Accumulation/distribution index 133

Accumulation/distribution index
Accumulation/distribution index is a technical analysis indicator intended to relate price and volume in the stock
market.

Formula

This ranges from -1 when the close is the low of the day, to +1 when it's the high. For instance if the close is 3/4 the
way up the range then CLV is +0.5. The accumulation/distribution index adds up volume multiplied by the CLV
factor, ie.

The starting point for the acc/dist total, ie. the zero point, is arbitrary, only the shape of the resulting indicator is
used, not the actual level of the total.
The name accumulation/distribution comes from the idea that during accumulation buyers are in control and the
price will be bid up through the day, or will make a recovery if sold down, in either case more often finishing near
the day's high than the low. The opposite applies during distribution.
The accumulation/distribution index is similar to on balance volume, but acc/dist is based on the close within the
day's range, instead of the close-to-close up or down that the latter uses.

Chaikin oscillator
A Chaikin oscillator is formed by subtracting a 10-day exponential moving average from a 3-day exponential
moving average of the accumulation/distribution index. Being an indicator of an indicator, it can give various sell or
buy signals, depending on the context and other indicators.

Similar indicators
Other Price × Volume indicators:
• Money Flow
• On-balance Volume
• Price and Volume Trend

See also
• Dimensional analysis - explains why volume and price are multiplied (not divided) in such indicators
Money Flow Index 134

Money Flow Index

Money Flow Index (MFI) is an oscillator calculated over an N-day period, ranging from 0 to 100, showing money
flow on up days as a percentage of the total of up and down days. Money flow in technical analysis is typical price
multiplied by volume, a kind of approximation to the dollar value of a day's trading.
The calculations are as follows. The typical price for each day is the average of high, low and close,

Money flow is the product of typical price and the volume on that day.

Totals of the money flow amounts over the given N days are then formed. Positive money flow is the total for those
days where the typical price is higher than the previous day's typical price, and negative money flow where below. (If
typical price is unchanged then that day is discarded.) A money ratio is then formed

From which a money flow index ranging from 0 to 100 is formed,

This can be expressed equivalently as follows. This form makes it clearer how the MFI is a percentage,

MFI is used as an oscillator. A value of 80 is generally considered overbought, or a value of 20 oversold.

Divergences between MFI and price action are also considered significant, for instance if price makes a new rally
high but the MFI high is less than its previous high then that may indicate a weak advance, likely to reverse.
It will be noted the MFI is constructed in a similar fashion to the relative strength index. Both look at up days against
total up plus down days, but the scale, i.e. what is accumulated on those days, is volume (or dollar volume
approximation rather) for the MFI, as opposed to price change amounts for the RSI.
It's important to be clear about what "money flow" means. It refers to dollar volume, i.e. the total value of shares
traded. Sometimes finance commentators speak of money "flowing into" a stock, but that expression only refers to
the enthusiasm of buyers (obviously there's never any net money in or out, because for every buyer there's a seller of
the same amount).
For the purposes of the MFI, "money flow", i.e. dollar volume, on an up day is taken to represent the enthusiasm of
buyers, and on a down day to represent the enthusiasm of sellers. An excessive proportion in one direction or the
other is interpreted as an extreme, likely to result in a price reversal.

Similar indicators
Other Price × Volume indicators:
• On-balance Volume
• Price and Volume Trend
• Accumulation/distribution index
On-balance volume 135

On-balance volume
On-balance volume (OBV) is a technical analysis indicator intended to relate price and volume in the stock market.
OBV is based on a cumulative total volume.[1]

The formula

Application
Total volume for each day is assigned a positive or negative value depending on prices being higher or lower that
day. A higher close results in the volume for that day to get a positive value, while a lower close results in negative
value.[2] So, when prices are going up, OBV should be going up too, and when prices make a new rally high, then
OBV should too. If OBV fails to go past its previous rally high, then this is a negative divergence, suggesting a weak
move.[3]
The technique, originally called "cumulative volume" by Woods and Vignolia, was later named in 1946, "on-balance
volume" by Joseph Granville who popularized the technique in his 1963 book Granville's New Key to Stock Market
Profits[1] . The index can be applied to stocks individually based upon their daily up or down close, or to the market
as a whole, using breadth of market data, i.e. the advance/decline ratio.[1]
OBV is generally used to confirm price moves.[4] The idea is that volume is higher on days where the price move is
in the dominant direction, for example in a strong uptrend more volume on up days than down days.[5]

Similar indicators
Other Price × Volume indicators:
• Money Flow
• Price and Volume Trend
• Accumulation/distribution index

See also
• Dimensional analysis — explains why volume and price are multiplied (not divided) in such indicators

References
[1] Joseph E. Granville, Granville's New Strategy of Daily Stock Market Timing for Maximum Profit, Prentice-Hall, Inc., 1976. ISBN
0-13-363432-9
[2] On Balance Volume ( OBV ) (http:/ / www. oxfordfutures. com/ futures-education/ tech/ on-balance-volume. htm). 22 September 2007.
[3] OBV Behaviorial Limitations and Formulas (http:/ / financial-edu. com/ on-balance-volume-obv. php) at Financial-edu.com.
[4] What Does On-Balance Volume Mean (http:/ / www. investopedia. com/ terms/ o/ onbalancevolume. asp)
[5] StockCharts.com article on On Balance Volume (http:/ / stockcharts. com/ education/ IndicatorAnalysis/ indic-OBV. htm)
Volume Price Trend 136

Volume Price Trend

Volume Price Trend (VPT) (sometimes Price Volume Trend) is a technical analysis indicator intended to relate
price and volume in the stock market. VPT is based on a running cumulative volume that adds or subtracts a multiple
of the percentage change in share price trend and current volume, depending upon their upward or downward
movements.[1]

Formula

The starting point for the VPT total, i.e. the zero point, is arbitrary. Only the shape of the resulting indicator is used,
not the actual level of the total.
VPT is similar to On-balance Volume (OBV),[2] but where OBV takes volume just according to whether the close
was higher or lower, VPT includes how much higher or lower it was.
VPT is interpreted in similar ways to OBV. Generally, the idea is that volume is higher on days with a price move in
the dominant direction, for example in a strong uptrend more volume on up days than down days. So, when prices
are going up, VPT should be going up too, and when prices make a new rally high, VPT should too. If VPT fails to
go past its previous rally high then this is a negative divergence, suggesting a weak move.

Similar indicators
Other Price × Volume indicators:
• Money Flow Index
• On-balance Volume
• Accumulation/distribution index

References
[1] Volume Price Trend Indicator - VPT (http:/ / www. investopedia. com/ terms/ v/ vptindicator. asp)
[2] Price/Volume Trend (http:/ / www. gannalyst. com/ Gannalyst_Professional/ Gannalyst_Indicators_Price_Volume_Trend. shtml)

External links
• STEP3_Tutorial (https://www.psg-online.co.za/Documentation/Webdocs/Education/STEP3_Tutorial.ppt)
• OUTPERFORMANCE WITH TECHNICAL ANALYSIS? — AN INTRADAY STUDY ON THE SWISS
STOCK MARKET (http://www.sbf.unisg.ch/org/sbf/web.nsf/SysWebRessources/
AmmannRekatevonWyss04/$FILE/TechAnalysis.pdf)
Force Index 137

Force Index
The Force Index (FI) is an indicator used in technical analysis to illustrate how strong the actual buying or selling
pressure is. High positive values mean there is a strong rising trend, and low values signify a strong downward trend.
The FI is calculated by multiplying the difference between the last and previous closing prices by the volume of the
commodity, yielding a momentum scaled by the volume. The strength of the force is determined by a larger price
change or by a larger volume.
The FI was created by Alexander Elder.

Negative volume index

Nearly 75 years have passed since Paul L. Dysart, Jr. invented the Negative Volume Index and Positive Volume
Index indicators. The indicators remain useful to identify primary market trends and reversals.
In 1936, Paul L. Dysart, Jr. began accumulating two series of advances and declines distinguished by whether
volume was greater or lesser than the prior day’s volume. He called the cumulative series for the days when volume
had been greater than the prior day’s volume the Positive Volume Index (PVI), and the series for the days when
volume had been lesser the Negative Volume Index (NVI).
A native of Iowa, Dysart worked in Chicago’s LaSalle Street during the 1920s. After giving up his Chicago Board of
Trade membership, he published an advisory letter geared to short-term trading using advance-decline data. In 1933,
he launched the Trendway weekly stock market letter and published it until 1969 when he died. Dysart also
developed the 25-day Plurality Index, the 25-day total of the absolute difference between the number of advancing
issues and the number of declining issues, and was a pioneer in using several types of volume of trading studies.

Dysart’s NVI and PVI

The daily volume of the New York Stock Exchange and the NYSE Composite Index’s advances and declines drove
Dysart’s indicators. Dysart believed that “volume is the driving force in the market.” He began studying market
breath numbers in 1931, and was familiar with the work of Col. Leonard P. Ayres and James F. Hughes, who
pioneered the tabulation of advances and declines to interpret stock market movements.
Dysart calculated NVI as follows: 1) if today’s volume is less than yesterday’s volume, subtract declines from
advances, 2) add the difference to the cumulative NVI beginning at zero, and 3) retain the current NVI reading for
the days when volume is greater than the prior day’s volume. He calculated PVI in the same manner but for the days
when volume was greater than the prior day’s volume. NVI and PVI can be calculated daily or weekly.
Initially, Dysart believed that PVI would be the more useful series, but in 1967, he wrote that NVI had “proved to be
the most valuable of all the breath indexes.” He relied most on NVI, naming it AMOMET, the acronym of “A
Measure Of Major Economic Trend.”
Dysart’s theory, expressed in his 1967 Barron's article, was that “if volume advances and prices move up or down in
accordance [with volume], the move is assumed to be a good movement - if it is sustained when the volume
subsides.” In other words, after prices have moved up on positive volume days, "if prices stay up when the volume
subsides for a number of days, we can say that such a move is 'good'." If the market “holds its own on negative
volume days after advancing on positive volume, the market is in a strong position.”
He called PVI the “majority” curve. Dysart distinguished between the actions of the “majority” and those of the
“minority.” The majority tends to emulate the minority, but its timing is not as sharp as that of the minority. When
the majority showed an appetite for stocks, the PVI was usually “into new high ground” as happened in 1961.
Negative volume index 138

It is said that the two indicators assume that "smart" money is traded on quiet days (low volume) and that the crowd
trades on very active days. Therefore, the negative volume index picks out days when the volume is lower than on
the previous day, and the positive index picks out days with a higher volume.

Dysart’s Interpretation of NVI and PVI

Besides an article he wrote for Barron’s in 1967, not many of Dysart’s writings are available. What can be interpreted
about Dysart’s NVI is that whenever it rises above a prior high, and the DJIA is trending up, a “Bull Market Signal”
is given. When the NVI falls below a prior low, and the DJIA is trending down, a “Bear Market Signal” is given. The
PVI is interpreted in reverse. However, not all movements above or below a prior NVI or PVI level generate signals,
as Dysart also designated “bullish” and “bearish penetrations.” These penetrations could occur before or after a Bull
or Bear Market Signal, and at times were called “reaffirmations” of a signal. In 1969, he articulated one rule: “signals
are most authentic when the NVI has moved sideways for a number of months in a relatively narrow range.” Dysart
cautioned that “there is no mathematical system devoid of judgment which will continuously work without error in
the stock market.”
According to Dysart, between 1946 and 1967, the NVI “rendered 17 significant signals,” of which 14 proved to be
right (an average of 4.32% from the final high or low) and 3 wrong (average loss of 6.33%). However, NVI
“seriously erred” in 1963-1964 and in 1968, which concerned him. In 1969, Dysart reduced the weight he had
previously given to the NVI in his analyses because NVI was no longer a “decisive” indicator of the primary trend,
although it retained an “excellent ability to give us ‘leading’ indications of short-term trend reversals.”
A probable reason for the NVI losing its efficacy during the mid-1960s may have been the steadily higher NYSE
daily volume due to the dramatic increase in the number of issues traded so that prices rose on declining volume.
Dysart’s NVI topped out in 1955 and trended down until at least 1968, although the DJIA moved higher during that
period. Norman G. Fosback has attributed the “long term increase in the number of issues traded” as a reason for a
downward bias in a cumulative advance-decline line. Fosback was the next influential technician in the story of NVI
and PVI.

Fosback’s Variations
Fosback studied NVI and PVI and in 1976 reported his findings in his classic Stock Market Logic. He did not
elucidate on the indicators’ background or mentioned Dysart except for saying that “in the past Negative Volume
Indexes have always [his emphasis] been constructed using advance-decline data….” He posited, “There is no good
reason for this fixation on the A/D Line. In truth, a Negative Volume Index can be calculated with any market index
- the Dow Jones Industrial Average, the S&P 500, or even ‘unweighted’ market measures…. Somehow this point has
escaped the attention of technicians to date.”
The point had not been lost on Dysart, who wrote in Barron’s, “we prefer to use the issues-traded data [advances and
declines] rather than the price data of any average because it is more all-encompassing, and more truly represents
what’s happening in the entire market.” Dysart was a staunch proponent of using advances and declines.
Fosback made three variations to NVI and PVI:
1. He cumulated the daily percent change in the market index rather than the difference between advances and
declines. On negative volume days, he calculated the price change in the index from the prior day and added it to the
most recent NVI. His calculations are as follows:
If Ct and Cy denote the closing prices of today and yesterday, respectively, the NVI for today is calculated by
• adding NVIyesterday (Ct - Cy) / Cy to yesterday's NVI if today's volume is lower than yesterday's, adding zero
otherwise,
and the PVI is calculated by:
Negative volume index 139

• adding PVIyesterday (Ct - Cy) / Cy to yesterday's PVI if today's volume is higher than yesterday's, adding zero
otherwise.
2. He suggested starting the cumulative count at a base index level such as 100.
3. He derived buy or sell signals by whether the NVI or PVI was above or below its one-year moving average.
Fosback’s versions of NVI and PVI are what are popularly described in books and posted on Internet financial sites.
Often reported are his findings that whenever NVI is above its one-year moving average there is a 96% (PVI - 79%)
probability that a bull market is in progress, and when it is below its one-year moving average, there is a 53% (PVI -
67%) probability that a bear market is in place. These results were derived using a 1941-1975 test period. Modern
tests might reveal different probabilities.
Today, NVI and PVI are commonly associated with Fosback’s versions, and Dysart, their inventor, is forgotten. It
cannot be said that one version is better than the other. While Fosback provided a more objective interpretation of
these indicators, Dysart’s versions offer value to identify primary trends and short-term trend reversals.
Although some traders use Fosback’s NVI and PVI to analyze individual stocks, the indicators were created to track,
and have been tested, on major market indexes. NVI was Dysart’s most invaluable breath index, and Fosback found
that his version of “the Negative Volume Index is an excellent indicator of the primary market trend.” Traders can
benefit from both innovations.

References
• Appel, Gerald, Winning Market Systems, pp. 42–44, Windsor Books, Bridgewaters, New York (1989)
• Dysart, Jr., Paul L., Bear Market Signal?: A Sensitive Breath Index Has Just Flashed One, Barron's (newspaper)
(Sept. 4, 1967)
• Fosback, Norman G., Stock Market Logic: A Sophisticated Approach to Profits on Wall Street, pp. 120–124,
Deaborn Financial Printing, Chicago, Illinois (1993)
• Market Technicians Association, Paul L. Dysart, Jr. Annual Award (1990, ed. James E. Alphier)
• Schade, Jr., George A., Traders Adjust the Volume Indicators, Stocks Futures and Options Magazine (Nov. 2005)
Ease of movement 140

Ease of movement
Ease of movement is an indicator used in technical analysis to relate an asset's price change to its volume. Ease of
Movement was developed by Richard W. Arms, Jr and highlights the relationship between volume and price changes
and is particularly useful for assessing the strength of a trend[1] . High positive values indicate the price is increasing
on low volume: strong negative values indicate the price is dropping on low volume. The moving average of the
indicator can be added to act as a trigger line, which is similar to other indicators like the MACD[2] .

References
[1] Arms Ease of Movement (http:/ / www. oxfordfutures. com/ futures-education/ tech/ ease-of-movement. htm), , retrieved 17 February 2008
[2] Financial dictionary.reference (http:/ / dictionary. reference. com/ browse/ ease of movement)
 141

INDICATORS: Volatility

Volatility (finance)
In finance, volatility most frequently refers to the standard deviation of the continuously compounded returns of a
financial instrument within a specific time horizon. It is common for discussions to talk about the volatility of a
security's price, even while it is the returns' volatility that is being measured. It is used to quantify the risk of the
financial instrument over the specified time period. Volatility is normally expressed in annualized terms, and it may
either be an absolute number ($5) or a fraction of the mean (5%).

Volatility terminology
Volatility as described here refers to the actual current volatility of a financial instrument for a specified period (for
example 30 days or 90 days). It is the volatility of a financial instrument based on historical prices over the specified
period with the last observation the most recent price. This phrase is used particularly when it is wished to
distinguish between the actual current volatility of an instrument and
• actual historical volatility which refers to the volatility of a financial instrument over a specified period but with
the last observation on a date in the past
• actual future volatility which refers to the volatility of a financial instrument over a specified period starting at
the current time and ending at a future date (normally the expiry date of an option)
• historical implied volatility which refers to the implied volatility observed from historical prices of the financial
instrument (normally options)
• current implied volatility which refers to the implied volatility observed from current prices of the financial
instrument
• future implied volatility which refers to the implied volatility observed from future prices of the financial
instrument
For a financial instrument whose price follows a Gaussian random walk, or Wiener process, the width of the
distribution increases as time increases. This is because there is an increasing probability that the instrument's price
will be farther away from the initial price as time increases. However, rather than increase linearly, the volatility
increases with the square-root of time as time increases, because some fluctuations are expected to cancel each other
out, so the most likely deviation after twice the time will not be twice the distance from zero.
Since observed price changes do not follow Gaussian distributions, others such as the Lévy distribution are often
used.[1] These can capture attributes such as "fat tails".

Volatility for investors

Investors care about volatility for five reasons. 1) The wider the swings in an investment's price the harder
emotionally it is to not worry. 2) When certain cash flows from selling a security are needed at a specific future date,
higher volatility means a greater chance of a shortfall. 3) Higher volatility of returns while saving for retirement
results in a wider distribution of possible final portfolio values. 4) Higher volatility of return when retired gives
withdrawals a larger permanent impact on the portfolio's value. 5) Price volatility presents opportunities to buy assets
cheaply and sell when overpriced. [2]
In today's markets, it is also possible to trade volatility directly, through the use of derivative securities such as
options and variance swaps. See Volatility arbitrage.
Volatility (finance) 142

Volatility versus direction

Volatility does not measure the direction of price changes, merely their dispersion. This is because when calculating
standard deviation (or variance), all differences are squared, so that negative and positive differences are combined
into one quantity. Two instruments with different volatilities may have the same expected return, but the instrument
with higher volatility will have larger swings in values over a given period of time.
For example, a lower volatility stock may have an expected (average) return of 7%, with annual volatility of 5%.
This would indicate returns from approximately -3% to 17% most of the time (19 times out of 20, or 95%). A higher
volatility stock, with the same expected return of 7% but with annual volatility of 20%, would indicate returns from
approximately -33% to 47% most of the time (19 times out of 20, or 95%). These estimates assume a normal
distribution; in reality stocks are found to be leptokurtotic.
Volatility is a poor measure of risk, as explained by Peter Carr, "it is only a good measure of risk if you feel that
being rich then being poor is the same as being poor then rich".

Volatility over time

Although the Black Scholes equation assumes predictable constant volatility, none of these are observed in real
markets, and amongst the models are Bruno Dupire's Local Volatility, Poisson Process where volatility jumps to new
levels with a predictable frequency, and the increasingly popular Heston model of Stochastic Volatility.[3]
It's common knowledge that types of assets experience periods of high and low volatility. That is, during some
periods prices go up and down quickly, while during other times they might not seem to move at all.
Periods when prices fall quickly (a crash) are often followed by prices going down even more, or going up by an
unusual amount. Also, a time when prices rise quickly (a bubble) may often be followed by prices going up even
more, or going down by an unusual amount.
The converse behavior, 'doldrums' can last for a long time as well.
Most typically, extreme movements do not appear 'out of nowhere'; they're presaged by larger movements than
usual. This is termed autoregressive conditional heteroskedasticity. Of course, whether such large movements have
the same direction, or the opposite, is more difficult to say. And an increase in volatility does not always presage a
further increase—the volatility may simply go back down again.

Mathematical definition
The annualized volatility σ is the standard deviation of the instrument's yearly logarithmic returns.
The generalized volatility σT for time horizon T in years is expressed as:

Therefore, if the daily logarithmic returns of a stock have a standard deviation of σSD and the time period of returns
is P, the annualized volatility is

A common assumption is that P = 1/252 (there are 252 trading days in any given year). Then, if σSD = 0.01 the
annualized volatility is

The monthly volatility (i.e., T = 1/12 of a year) would be

Volatility (finance) 143

The formula used above to convert returns or volatility measures from one time period to another assume a particular
underlying model or process. These formulas are accurate extrapolations of a random walk, or Wiener process,
whose steps have finite variance. However, more generally, for natural stochastic processes, the precise relationship
between volatility measures for different time periods is more complicated. Some use the Lévy stability exponent α
to extrapolate natural processes:

If α = 2 you get the Wiener process scaling relation, but some people believe α < 2 for financial activities such as
stocks, indexes and so on. This was discovered by Benoît Mandelbrot, who looked at cotton prices and found that
they followed a Lévy alpha-stable distribution with α = 1.7. (See New Scientist, 19 April 1997.)

Crude volatility estimation

Using a simplification of the formulas above it is possible to estimate annualized volatility based solely on
approximate observations. Suppose you notice that a market price index, which has a current value near 10,000, has
moved about 100 points a day, on average, for many days. This would constitute a 1% daily movement, up or down.
To annualize this, you can use the "rule of 16", that is, multiply by 16 to get 16% as the annual volatility. The
rationale for this is that 16 is the square root of 256, which is approximately the number of trading days in a year
(252). This also uses the fact that the standard deviation of the sum of n independent variables (with equal standard
deviations) is √n times the standard deviation of the individual variables.
Of course, the average magnitude of the observations is merely an approximation of the standard deviation of the
market index. Assuming that the market index daily changes are normally distributed with mean zero and standard
deviation σ, the expected value of the magnitude of the observations is √(2/π)σ = 0.798σ. The net effect is that this
crude approach overestimates the true volatility by about 25%.

Estimate of compound annual growth rate (CAGR)

Consider the Taylor series:

Taking only the first two terms one has:

Realistically, most financial assets have negative skewness and leptokurtosis, so this formula tends to be
over-optimistic. Some people use the formula:

for a rough estimate, where k is an empirical factor (typically five to ten).

See also
• Beta (finance)
• Derivative (finance)
• Financial economics
• Implied volatility
• IVX
• Risk
• Standard deviation
• Stochastic volatility
• Volatility arbitrage
Volatility (finance) 144

• Volatility smile

References
[1] http:/ / www. wilmottwiki. com/ wiki/ index. php/ Levy_distribution
[2] Investment Risks - Price Volatility (http:/ / www. retailinvestor. org/ risk. html#volatility)
[3] http:/ / www. wilmottwiki. com/ wiki/ index. php/ Volatility#Definitions

• Lin Chen (1996). Stochastic Mean and Stochastic Volatility – A Three-Factor Model of the Term Structure of
Interest Rates and Its Application to the Pricing of Interest Rate Derivatives. Blackwell Publishers.

External links
• Complex Options (http://www.optionistics.com/f/strategy_calculator) Multi-Leg Option Strategy Calculator
• An introduction to volatility and how it can be calculated in excel, by Dr A. A. Kotzé (http://quantonline.co.za/
Articles/article_volatility.htm)
• Interactive Java Applet " What is Historic Volatility? (http://www.frog-numerics.com/ifs/ifs_LevelA/
HistVolaBasic.html)"
• Diebold, Francis X.; Hickman, Andrew; Inoue, Atsushi & Schuermannm, Til (1996) "Converting 1-Day
Volatility to h-Day Volatility: Scaling by sqrt(h) is Worse than You Think" (http://citeseer.ist.psu.edu/244698.
html)
• A short introduction to alternative mathematical concepts of volatility (http://staff.science.uva.nl/~marvisse/
volatility.html)

Average True Range

Average True Range (ATR) is a technical analysis volatility indicator originally developed by J. Welles Wilder, Jr.
for commodities[1] . The indicator does not provide an indication of price trend, simply the degree of price
volatility.[2] The average true range is an N-day exponential moving average of the true range values. Wilder
recommended a 14-period smoothing. [3]

Calculation
The range of a day's trading is simply . The true range extends it to yesterday's closing price if it was
outside of today's range.

The true range is the largest of the:

• Most recent period's high less the most recent period's low
• Absolute value of the most recent period's high less the previous close
• Absolute value of the most recent period's low less the previous close
The idea of ranges is that they show the commitment or enthusiasm of traders. Large or increasing ranges suggest
traders prepared to continue to bid up or sell down a stock through the course of the day. Decreasing range suggests
waning interest.
Average True Range 145

References
[1] J. Welles Wilder, Jr. (June 1978). New Concepts in Technical Trading Systems. Greensboro, NC: Trend Research. ISBN 978-0894590276.
[2] ATR Definition - investopedia.com (http:/ / www. investopedia. com/ terms/ a/ atr. asp)
[3] This is by his reckoning of EMA periods, meaning an α=2/(1+14)=0.1333.

External links
• Measure Volatility With Average True Range (http://www.investopedia.com/articles/trading/08/
average-true-range.asp) at investopedia.com
• Enter Profitable Territory With Average True Range (http://www.investopedia.com/articles/trading/08/ATR.
asp) at investopedia.com
• Average True Range (ATR) (http://stockcharts.com/help/doku.
php?id=chart_school:technical_indicators:average_true_range_a) at stockcharts.com

Bollinger Bands
Bollinger Bands is a technical analysis
tool invented by John Bollinger in the
1980s. Having evolved from the
concept of trading bands, Bollinger
Bands can be used to measure the
highness or lowness of the price
relative to previous trades.

Bollinger Bands consist of:

• a middle band being an N-period
simple moving average (MA)
• an upper band at K times an
N-period standard deviation above
the middle band (MA + Kσ)
• a lower band at K times an N-period
standard deviation below the middle
band (MA − Kσ) S&P 500 with 20 day, two standard deviation Bollinger Bands, %b and BandWidth.
Typical values for N and K are 20 and
2, respectively. The default choice for the average is a simple moving average, but other types of averages can be
employed as needed. Exponential moving averages are a common second choice. [1] Usually the same period is used
for both the middle band and the calculation of standard deviation.[2]
Bollinger Bands 146

Purpose
The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition, prices are high at
the upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in
comparing price action to the action of indicators to arrive at systematic trading decisions.[3]

Indicators derived from Bollinger Bands

There are two indicators derived from Bollinger Bands, %b and BandWidth.
%b, pronounced 'percent b', is derived from the formula for Stochastics and tells you where you are in relation to the
bands. %b equals 1 at the upper band and 0 at the lower band. Writing upperBB for the upper Bollinger Band,
lowerBB for the lower Bollinger Band, and last for the last (price) value:
%b = (last − lowerBB) / (upperBB − lowerBB)
BandWidth tells you how wide the Bollinger Bands are on a normalized basis. Writing the same symbols as before,
and middleBB for the moving average, or middle Bollinger Band:
BandWidth = (upperBB − lowerBB) / middleBB
Using the default parameters of a 20-period look back and plus/minus two standard deviations, BandWidth is equal
to four times the 20-period coefficient of variation.
Uses for %b include system building and pattern recognition. Uses for BandWidth include identification of
opportunities arising from relative extremes in volatility and trend identification.
In a series of lectures at The World Money Show in Hong Kong, Asian Traders Investment Conference in Singapore,
the Italian Trading Forum in Rimini, Italy, The European Technical Analysis Conference in London, England and
the Market Technicians Symposium in New York, USA, all in Spring of 2010, John Bollinger introduced three new
indicators based on Bollinger Bands. They are BB Impulse, which measures price change as a function of the bands,
BandWidth Percent, which normalizes the width of the bands over time, and BandWidth Delta, which quantifies the
changing width of the bands.

Interpretation
The use of Bollinger Bands varies widely among traders. Some traders buy when price touches the lower Bollinger
Band and exit when price touches the moving average in the center of the bands. Other traders buy when price
breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger Band.[4] Moreover, the use
of Bollinger Bands is not confined to stock traders; options traders, most notably implied volatility traders, often sell
options when Bollinger Bands are historically far apart or buy options when the Bollinger Bands are historically
close together, in both instances, expecting volatility to revert back towards the average historical volatility level for
the stock.
When the bands lie close together a period of low volatility in stock price is indicated. When they are far apart a
period of high volatility in price is indicated. When the bands have only a slight slope and lie approximately parallel
for an extended time the price of a stock will be found to oscillate up and down between the bands as though in a
channel.
Traders are often inclined to use Bollinger Bands with other indicators to see if there is confirmation. In particular,
the use of an oscillator like Bollinger Bands will often be coupled with a non-oscillator indicator like chart patterns
or a trendline; if these indicators confirm the recommendation of the Bollinger Bands, the trader will have greater
evidence that what the bands forecast is correct.
Bollinger Bands 147

Effectiveness
A recent study concluded that Bollinger Band trading strategies may be effective in the Chinese marketplace, stating:
"Finally, we find significant positive returns on buy trades generated by the contrarian version of the moving average
crossover rule, the channel breakout rule, and the Bollinger Band trading rule, after accounting for transaction costs
of 0.50 percent." Nauzer J. Balsara, Gary Chen and Lin Zheng The Chinese Stock Market: An Examination of the
Random Walk Model and Technical Trading Rules.[5] (By "the contrarian version", they mean buying when the
conventional rule mandates selling, and vice versa.)
A paper by Rostan, Pierre, Théoret, Raymond and El moussadek, Abdeljalil from 2008 at SSRN uses Bollinger
Bands in forecasting the yield curve.[6]
In his 2006 master's thesis, Oliver Douglas Williams at the University of Western Ontario studied Bollinger Bands
and suggested that fundamental analysis was key to setting Bollinger Band parameters, a process John Bollinger
dubbed rational analysis. Williams concluded: "Alone, Bollinger Bands do not seem to yield the extraordinary
results. Fundamental analysis is required to determine the best moving average window to match the business cycle
of the asset. When combined with other techniques such as fundamental analysis, Bollinger Bands can give
systematic traders a method of choosing their buy and sell points."[7]
Companies like Forbes suggest that the use of Bollinger Bands is a simple and often an effective strategy but
stop-loss orders should be used to mitigate losses from market pressure.[8]

Statistical properties
Security prices have no known statistical distribution, normal or otherwise; they are known to have fat tails,
compared to the Normal.[9] The sample size typically used, 20, is too small for conclusions derived from statistical
techniques like the Central Limit Theorem to be reliable. Such techniques usually require the sample to be
independent and identically distributed which is not the case for a time series like security prices.
For these three primary reasons, it is incorrect to assume that the percentage of the data outside the Bollinger Bands
will always be limited to a certain amount. So, instead of finding about 95% of the data inside the bands, as would be
the expectation with the default parameters if the data were normally distributed, one will typically find less; how
much less is a function of the security's volatility.

Bollinger Bands outside of finance

In a paper published in 2006 by the Society of Photo-Optical Engineers, "Novel method for patterned fabric
inspection using Bollinger Bands", Henry Y. T. Ngan and Grantham K. H. Pang present a method of using Bollinger
Bands to detect defects in patterned fabrics. From the abstract: "In this paper, the upper band and lower band of
Bollinger Bands, which are sensitive to any subtle change in the input data, have been developed for use to indicate
the defective areas in patterned fabric."[10]
The International Civil Aviation Organization is using Bollinger Bands to measure the accident rate as a safety
indicator to measure efficiency of global safety initiatives.[11] %b and BandWidth are also used in this analysis.
Bollinger Bands 148

Notes
[1] When the average used in the calculation of Bollinger Bands is changed from a simple moving average to an exponential or weighted moving
average, it must be changed for both the calculation of the middle band and the calculation of standard deviation.Bollinger On Bollinger
Bands – The Seminar, DVD I ISBN 978-0-9726111-0-7
[2] Bollinger Bands use the population method of calculating standard deviation, thus the proper divisor for the sigma calculation is n, not n − 1.
[3] (http:/ / www. bollingerbands. com) second paragraph, center column
[4] Technical Analysis: The Complete Resource for Financial Market Technicians by Charles D. Kirkpatrick and Julie R. Dahlquist Chapter 14
[5] (http:/ / findarticles. com/ p/ articles/ mi_qa5466/ is_200704/ ai_n21292807/ pg_1?tag=artBody;col1) The Quarterly Journal of Business and
Economics, Spring 2007
[6] (http:/ / papers. ssrn. com/ sol3/ papers. cfm?abstract_id=671581) Forecasting the Interest-Rate Term Structure at SSRN
[7] (http:/ / ir. lib. sfu. ca/ retrieve/ 3836/ etd2519. pdf) Empirical Optimization of Bollinger Bands for Profitability
[8] Bollinger Band Trading John Devcic 05.11.07 (http:/ / www. forbes. com/ 2007/ 05/ 11/
bollinger-intel-yahoo-pf-education-in_jd_0511chartroom_inl. html)
[9] Rachev; Svetlozar T., Menn, Christian; Fabozzi, Frank J. (2005), Fat Tailed and Skewed Asset Return Distributions, Implications for Risk
Management, Portfolio Selection, and Option Pricing, John Wiley, New York
[10] (http:/ / spiedl. aip. org/ getabs/ servlet/ GetabsServlet?prog=normal& id=OPEGAR000045000008087202000001& idtype=cvips&
gifs=yes) Optical Engineering, Volume 45, Issue 8
[11] (http:/ / www. skybrary. aero/ index. php/ ICAO_Methodology_for_Accident_Rate_Calculation_and_Trending) ICAO Methodology for
Accident Rate Calculation and Trending on SKYbary

References

Further reading
• Achelis, Steve. Technical Analysis from A to Z (pp. 71–73). Irwin, 1995. ISBN 978-0-07-136348-8
• Bollinger, John. Bollinger on Bollinger Bands. McGraw Hill, 2002. ISBN 978-0-07-137368-5
• Cahen, Philippe. Dynamic Technical Analysis. Wiley, 2001. ISBN 978-0-471-89947-1
• Kirkpatrick, Charles D. II; Dahlquist, Julie R. Technical Analysis: The Complete Resource for Financial Market
Technicians, FT Press, 2006. ISBN 0-13-153113-1
• Murphy, John J. Technical Analysis of the Financial Markets (pp. 209–211). New York Institute of Finance,
1999. ISBN 0-7352-0066-1

External links
• John Bollinger's website (http://www.bollingerbands.com)
• John Bollinger's website on Bollinger Band analysis (http://www.bollingeronbollingerbands.com)
• December 2008 Los Angeles Times profile of John Bollinger (http://www.latimes.com/business/
la-fi-himi7-2008dec07,0,1338099.story)
Donchian channel 149

Donchian channel
The Donchian channel is an indicator used in market trading developed by Richard Donchian. It is formed by taking
the highest high of the daily maxima and the lowest low of the daily minima of the last n days, then marking the area
between those values on a chart.
The Donchian channel is a useful indicator for seeing the volatility of a market price. If a price is stable the
Donchian channel will be relatively narrow. If the price fluctuates a lot the Donchian channel will be wider. Its
primary use, however, is for providing signals for long and short positions. If a security trades above its highest n
day high, then a long is established. If it trades below its lowest n day low, then a short is established.

See also
• Bollinger bands
• Financial modeling

External links
• Using the Donchian Channel in Trading [1]
• Capture Profits using Bands and Channels [2]

References
[1] http:/ / www. indicatorforex. com/ content/ using-donchian-bands
[2] http:/ / www. investopedia. com/ articles/ forex/ 06/ BandsChannels. asp

Standard deviation
Standard deviation is a widely used
measurement of variability or diversity
used in statistics and probability
theory. It shows how much variation or
"dispersion" there is from the
"average" (mean, or expected/budgeted
value). A low standard deviation
indicates that the data points tend to be
very close to the mean, whereas high
standard deviation indicates that the
data are spread out over a large range A plot of a normal distribution (or bell curve). Each colored band has a width of one
of values. standard deviation.

Technically, the standard deviation of

a statistical population, data set, or probability distribution is the square root of its variance. It is algebraically
simpler though practically less robust than the average absolute deviation.[1]