Prediction Wizard

If we are index traders or  using related asset classes in our trading (ETF-s, Options, Futures, CFD-s) than  we  involved in market status identification.

Though we have our own proprietary system to help us in market status identification, containing well over  200 calculated  indicator data  I would like to write about  some of the most important, and at the same time generally available  indicators in this series.

Most service packages  support these indicators:

- A / D Line, A/D Indicator

- TICK

- Volume Indicator TRIN

- VIX

- VOMUME

When a doctor try to make the diagnosis and analyzing   the blood  test result of a patient, containing more than 50 detailed data,  not looking at every data  by detail, but try to  find some pattern, and  uses a top – down approach to either confirm or disconfirm  his / her hypothesis  for the idea.

Similarly when we try to use a top – down approach  for the market status identification, than  these indicators come handy.

The importance and usability of any specific  market indicator  will vary in time.

A trader pro will know  what indicator to look at what time.

The importance of  a specific market indicator might be crucial for decision making at one type of market during certain market conditions, and  largely unimportant during other market conditions.

From those mentioned above,  our favorite is the A/D line Advance – Decline line.

Using eSignal, which is our real-time platform for market data,  the symbol for this A/D line is $ADV for the NYSE market and $ADVQ for the NASDAQ market.

Yes it would be good to have separate A/D line for each indices (S&P500, S&P400, S&P600…) but it is if fine  to have at least  the  two most important  A/D lines available.

The A/D line, its  properties, its  usefulness, applicability  and weaknesses.

We  would like to highlight, that being a predictionwizard trader  or investor  we are not following this every minute, not even  every five minutes,  only occasionally during the trading day when we feel the need for this status data, either for confirmation or non-confirmation.

After some experience we will know when  will it be needed.

- The A/D line  is the simple most robust indicator,  it is misleading the least   amount of time.

  For this reason its non-confirmation with the price movement is a serious warning sign.

- To quickly determine the direction of the A/D line we put two more indicator on top of that, the SMA10 and the WMA10 moving averages. (The 10 period simple moving average, and the 10   period weighted moving average.)

  If the WMA10 direction is upward, and the WMA10 is above the SMA10, than  we  can conclude,   that the A/D line is moving up  in the selected time-frame.

  If the WMA10 direction is down, and the WMA10 is below the SMA10, than we can conclude, that the A/D line moving  down in our selected time-frame.

With  the A/D   line we usually  use the following time frames (1min, 3 min, 5 min, 60 min, 5 min being the norm, and occasionally checking the other time-frames)

- The weakness of the A/D  line is that  it is a LAGGING indicator,  so most of the time we don’t  look at that to get a clue for  future market direction, but  rather to confirm a specific movement  in price.

- Though the direction of the A/D line has  not  much  predictive power for future market direction, the level of the A/D   does have a bit more predictive power. To  demonstrate this, we created the following  drawing for the  NASDAQ A/D line:

Excluding the first 15 – 60 minutes after  the market open, the A/D level have a  fairly good predictive capability for future market movements during the day. That is why we presented our trading preferences on the drawing.

On the above drawing we noted three distinct Range levels for the A/D values.

 - Bullish Range

 - Neutral Range

 - Bearish Range

It does not mean that we  never   short the index, when the A/D is in the Bullish range, only means  that the overwhelming majority of our trades  is in the presented direction.

(The exceptions are in case of Big GAP Up and Big GAP Down, when we have  extreme A/D, but when  A/D level have  lower significance.)

When the A/D line moves within the Neutral range, than we have increased probability for a range market.

The most useful the A/D  for general market status identification, when we do not have big gaps at the open. The bigger the GAPs, the less useful the A/D level is  in our interpretation for our trading decision especially for the beginning of the trading day.

Note that we could  create  similar drawing for the NYSE market, but with a bit different levels between Bullish / Neutral / Bearish markets, as the number of stocks in that market is different.

Also note that the Level of the A/D  during the first 10 – 30 minutes have less value / significance, as it is  changing too  dynamically.

Sometimes  the stocks not started trading on the NYSE at 9.30.   Sometimes the  specialist open for trading at 9.31, 9.32.. or even later  at 9.35, according to some of our studies.

The NASDAQ is completely different.  It is  9.30  precisely as it is  a computer system controlled market.

The A/D line might have divergences  with price movements.  That is  when  the price is going Up and the A/D line does not confirm, it is going nowhere or even going down.

Other times, the A/D line can move Up and price move down or going nowhere.

The difficulty to  evaluate the  importance of those divergences lies in the fact,  that  the importance of A/D – Price divergence also depends on the A/D level itself.

One example:  It  we already have a very strong  A/D of 1800 for the NASDAQ, and at the end of the day the price moving up, but the A/D does not move Up at all,  that does not mean, that  we need to jump in and short.

The indices can move  higher, when we have that very high A/D  even if some  little weighted companies  in those capital – weighted indices  experience sell-off, assuming that the  heavy–weighted  stocks in the index  continue  to move a bit upward.

Obviously a limited  participation to the upside / downside is a warning sign, that a move might soon end.

We can define another derived indicator, the so-called A/D efficiency,   which  is the price change  in the index, divided by the A/D change in the A/D line.

The difficulty of the applicability of  A/D efficiency is that its value  and meaning also depends on  the A/D level itself.

Sometime we get a lot of A/D change, and only a little  bit of price change in the same direction.

That happens usually at the beginning of the day.

In this case A/D efficiency is small.

If  the A/D already 1800 for the NASDAQ index and it moves up another 100 to 1900, than the A/D change is 100,  If the index moves up 0.1%   than this A/D efficiency  is 0.1 / 100 = 0.001

If the price moves down 0.1%, than the A/D efficiency is Negative, it is -0.001.

When we have negative divergences between A/D and index / price, than  the A/D efficiency is also negative.  It can be a kind of  measure for   the extent of  positive / negative divergence.

Looking at multiple charts, between the NASDAQ A//D Line and NYSE A/D line  we might also discover  divergences,  additional potential clue before market turning points.

The overwhelming majority of intraday A/D lines  could be  categorized  and  identified as one of the following  A/D  curve  presented on the following drawing:

During a specific day, most  of the time we have  either a one swing  A/D line, a two swings A/D line or a three swings A/D line.

If we   think about any trading day,  with three distinct time periods, the Morning session, the Midday session and the Afternoon session, than the  intraday A/D line can be seen as the activity or summed  opinion of  the players in the morning, midday and afternoon.

If the majority of the afternoon players  still playing the same direction as the morning session players, than we might experience the one swing A/D line with a much higher probability, which is usually the A/D line  on strong trending days.

Most often turns in the A/D line  happens either in the morning session or in the afternoon session. Usually the A/D line changes the smallest during the Midday session.

Traders  looking at  patterns on all charts.  The patterns that could be  identified only by looking at one chart are usually the simplest patterns.

There are more complex patterns,  that  encompass the usage of multiple charts and those are more difficult to find, and usually mush less  exploited by traders.

There are many other flavors  of A/D.  The A/D ratio also widely used by traders.

Using the Daily timeframe  we can exploit many other  A/D – related indicators,  so-called breath indicators.

One favorite  is the McClellan oscillator  which is widely  used  by swing traders.