Stocksweeper Technicals

Hundreds of technicals have been developed since the early 20th century, and today the choice of which ones to use—and how to configure and interpret them—is largely a matter of personal preference. However, a few technicals, along with their recommended configurations and interpretations, have clearly risen over time to become more popular than others; these technicals appear more regularly in financial literature and mainstream reporting such as on CNBC. In fact, these technicals’ widespread popularity may contribute, at least in part, to their success: the more people that trade using a given technical, the better that technical reflects trader decision-making and predicts future price movements.

StockSweeper currently offers a selection of 10 of these popular technicals in their common configurations, like the 14-period RSI mentioned in the CNBC report linked above. Here, each of these technicals are described as they are configured in StockSweeper, along with a brief introductory tutorial on their recommended interpretations to assist newcomers in their usage.

Simple Moving Average (SMA)

A security’s N-day simple moving average is a moving arithmetic mean of the security’s closing price calculated over the last N days. SMA lines often function as support or resistance levels for price action—that is to say, a security’s price tends to “rebound” off these lines rather than crossing through them. If price action does cross through an SMA line, it implies that trader enthusiasm was sufficient to break through that support or resistance level, which is commonly recognized as a bullish or bearish signal. Finally, as a rule of thumb, longer-term SMAs generally exhibit more “firmness” than shorter-term SMAs: they resist price action more strongly, and they imply a stronger bullish or bearish signal when crossed through.

In addition to observing SMA lines against a security’s price action, technical traders also frequently observe SMA lines in relation to one another. When a security’s shorter-term SMA crosses above that security’s longer-term SMA, this is considered indicative of a bullish trend; conversely, when a security’s longer-term SMA crosses above that security’s shorter-term SMA, this is considered indicative of a bearish trend.

The thumbnail chart to the right shows historical daily stock data for Sun Microsystems, Inc. (today a wholly-owned subsidiary of Oracle Corporation) along with two of the most common moving average lines in technical analysis, the 20-day SMA and 50-day SMA. (Click to Expand)

Sun’s price rebounds up several times off of the 50-day SMA support during its climb throughout 1999 year. In 2000, Sun’s price breaks below the 50-day SMA; (a short-term bearish signal) but rebounds off the stronger 200-day line. In November of 2000, Sun’s price breaks below the 200-day line, (a stronger, longer-term bearish signal) and continues sharply lower into the month ahead. At this point, Sun’s 50-day SMA, which had previously been sideways due to decaying upward momentum, here turns downward and crosses below its 200-day SMA, signaling that this downtrend may continue for some time.

StockSweeper offers automated alerts for the highly common 50- and 200-day SMAs. A shorter-term SMA, the 20-day, is also included as part of the Bollinger Bands indicator.

Exponential Moving Average

Another highly popular type of moving average, an N-day exponential moving average is a modified version of the SMA that places greater weight on more recent data. This enables the EMA to react faster—that is, to generate alerts sooner, with less lag—following a change in price trend compared to an SMA of comparable length. It is otherwise interpreted identically to the SMA, with respect to price action and EMA crossovers of different periods.

Hull Moving Average 20d/30d Crossover

Whereas the SMA and EMA have been in use for many decades, the Hull moving average (HMA) is a more contemporary version, invented circa 2005 by technical analyst Alan Hull. In a similar vein to the EMA, Hull presented his HMA as a less laggy alternative to other moving averages—in fact, it is even more responsive to fluctuations in price than the EMA. As a result of its extreme sensitivity, the HMA is not traditionally used with price crosses; more commonly it is interpreted using inflections (when the HMA turns upward or downward) or crossovers between multiple HMAs.

At the moment, StockSweeper features a 20-day/30-day HMA crossover indicator. As usual for crossover-style indicators, the faster line crossing above the slower line is interpreted as a bullish signal, while the slower line crossing above the faster line is interpreted as a bearish signal.

HMA inflection indicators may be included in a later update.

Relative Strength Index

The RSI is another of the most highly popular and commonly-cited technicals. Unlike the previous indicators discussed here so far, RSI is a momentum indicator: it evaluates the strength of a security’s recent price action, operating on the assumption that price movements in a given direction are often not immediately completed but rather accompanied by a “momentum” that prolongs them in that same direction for a time before reversing. (For the curious: this assumption, while empirically well-documented, remains to date poorly explained by modern financial theory and is the subject of ongoing academic research.)

The RSI is also a bounded indicator: its values range only from 0 to 100. The higher end of that range, commonly defined as 70 and above, is interpreted as the “overbought” or overvalued region. When a security’s RSI is in this region, it may be primed for a corrective pullback in price, or even a trend reversal. The same principles apply to the lower end of the RSI range, commonly 30 and below, which is interpreted as the “oversold” or undervalued region and may herald the same pullback or reversal.

Importantly, since in the case of strong trends a security’s RSI may remain in overbought or oversold territory for a considerable amount of time after entering, the bullish or bearish signal is not traditionally recognized until the moment RSI exits one of these regions (accordingly StockSweeper sorts overbought/oversold region entry events as “neutral” signals to avoid confusion).

Another interpretation of RSI is to look for divergences with respect to price action—circumstances in which an security’s RSI movement does not mirror its price movement in direction and/or magnitude. This is most easily explained visually: the attached chart demonstrates two instances of one such divergence, a negative divergence, in which the euro/franc spot price marks higher highs while RSI (shown below) is at the same time hitting lower highs, thereby forecasting a downward turn. This particular example uses the most common configuration settings for RSI: a 14-day lookback period, overbought ;> 70 (blue line), and oversold ;< 30 (red line). These are the very same settings used by StockSweeper’s RSI.

Moving Average Convergence Divergence

Practically never addressed by its unabbreviated name, the MACD is another common momentum indicator. It uses three moving averages (EMAs, to be precise) to generate two lines: the standard MACD line, shown in solid black in the chart above, and a slower, “signal” line, shown in dotted blue. These two lines are interpreted in the same style as other MA-based crossovers discussed above: the (faster) MACD line crossing above the (slower) signal line is considered a bullish signal, while the signal line crossing above the MACD line is considered a bearish signal.

Unlike the RSI, the MACD is unbounded—it has no “oversold” or “overbought” territory. Rather its two EMA-derived lines are plotted around a zero line that distinguishes positive from negative territory. When the MACD line is above zero, this is considered a sign of bullish momentum, whereas when the MACD line is above zero, this is considered a sign of bearish momentum. As the attached chart demonstrates, the zero line can also at times function as a support or resistance level for the indicator.

StockSweeper uses the most common configuration for MACD: the two EMAs used to derive the MACD line are of lengths 12 and 26, while the third EMA used to generate the signal line is of length 9.

Bollinger Bands

Bollinger Bands®—invented by John Bollinger in the early 1980s and trademarked by him in 2011 due to rising popularity—consist mathematically of an N-day SMA surrounded by two “band” lines, an upper band and lower band, each of which which are K standard deviations of length N above and below the SMA.

In Bollinger’s original design (which has remained the most popular over the years), N = 20 and K = 2, such that the indicator becomes a 20-day SMA surrounded by bands that are 2 standard deviations away and also of length 20. The attached example shows Bollinger bands in this configuration.

As the chart demonstrates, the upper and lower Bollinger bands function as “moving bounds” for the security’s price: they tend to act as very strong support/resistance levels, and the vast majority of price action occurs between them. Any breakout of price action above the upper band or below the lower band, therefore, is a significant event.

Some traders consider the breakout itself to be a trading signal—breaking out above the upper being bullish, breaking out below the lower being bearish—and while StockSweeper does provide neutral notifications for breakouts for optional use, commonly traders will act not on the breakout but rather on the return to bounded behavior, such that crossing above the lower band is considered bullish, and crossing below the upper band is considered bearish. The middle line, as a 20-day SMA, can also be interpreted with respect to price action in the same way as the 50- and 200-day SMAs.

Full Stochastic Oscillator

Similar to MACD, the Stochastic Oscillator attempts to evaluate a security’s momentum by mathematically deriving a “fast” line (here called %K, shown in the attached graph in black) and comparing it against a slower “signal” line (here called %D, in red). As with the previous crossover indicators, when the faster %K line crosses above the slower %D line, it is recognized as a bullish signal, and when the slower %D line crosses above the faster %K line, it is recognized as a bearish signal.

Unlike MACD, however, the Stochastic Oscillator is a bounded indicator, with overbought and oversold regions. Crossovers of the matching type that occur inside these regions (for example, a bearish crossover in the overbought region) are considered stronger signals than crossovers that occur in the middle zone; many traders even choose to disregard those crossovers that do not occur in one of the two extreme regions. Additionally, in periods of strong momentum, the oscillator may be observed to “float” for extended periods of time in an extreme region, generating many false crossover signals—to counteract this, traders often wait for a crossover that results in a signal (slow) line exit from the extreme region, as highlighted by the arrows in the attached graph.

Over the decades since the 1950s when this indicator was created, many different types and configurations of the Stochastic Oscillator have achieved mainstream popularity. Some are calculated with longer periods, resulting in smoother lines and less frequent but presumably more significant signals, while others are calculated with very short periods, resulting in choppy lines that respond quicker to changes in price action but generate more false signals.

Currently StockSweeper includes just two of these many possible configurations: a slow oscillator with a long lookback period of 21 days for slightly longer lag but fewer false signals (21, 7, 7); and a fast oscillator with a much shorter lookback period of 5 days for more immediate and frequent signals at the risk of greater false positives (5, 3, 3). Future updates of StockSweeper may include alternative configurations.

Wilder's DMI/ADX

Developed in the same year by the same person (J. Welles Wilder) who created RSI, the “average directional index” ADX is unlike any other indicator previously presented on this page so far. Rather than estimating the momentum of price oscillations, ADX attempts to estimate trend, that is, the broader direction of price action over time. It is nondirectional: it cannot dictate on its own whether a trend is bullish or bearish; rather, it seeks to identify when a trend is present or absent, or when it is changing.

To begin, the value of ADX determines the strength of the current trend. Precisely which values correspond to which levels of strength is a matter of subjectivity, but commonly-used estimates are as follows:

Low ADX values may indicate bounded price behavior (where a security’s price oscillates between a support and a resistance for a time), but it may also simply indicate sideways movement (where a security’s price trades flat).

ADX reaching a higher value implies that the security’s price has broken out of bounded behavior and has begun to trend. If DI+ is higher than DI- at that time, it suggests a bullish trend. If DI- is higher than DI+ at that time, it suggests a bearish trend. While a security is exhibiting trend behavior, it is commonly recommended not to trade against the direction of the trend, i.e. any short-term reversal signals that are not confirmed by a weakening trend are usually disregarded.

Trend weakening can be forecasted by downward inflection of ADX. When ADX turns downwards, it implies that the current trend (whether bullish or bearish) is weakening and indicates a reversal or a return to bounded movement. ADX therefore can (and should) be used in conjunction with other indicators, for example a bounded indicator like MACD or RSI, to align momentum signals with trend signals and achieve higher likelihoods of a profitable trade.

StockSweeper uses the original configuration of DMI and ADX with a 14-day length as outlined by Wilder in 1978. It remains the most popular ADX configuration to date.

Commodity Channel Index

As its name would suggest, the CCI was originally created to technically analyze the price of commodities—including oil, copper, and other raw materials—but in fact the CCI can be (and regularly is) used in other markets just as effectively.

The CCI is an unbounded oscillator that compares a security’s current price against its average price over a length of time. High CCI values signify that current prices are meaningfully above their average for that time; conversely, low CCI values signify that current prices are meaningfully below their average for that time.

Thus the original and most common interpretation of CCI as offered by its creator Donald Lambert was that a cross above +100 is a bullish signal, ending when CCI crosses back below +100; similarly, a cross below -100 is a bearish signal, ending when CCI crosses back above -100. An example of this reading shown for historical data for Caterpillar, Inc. (CAT) is shown in the attached chart.

More extreme values above +200 and -200 are oftentimes more atypical and may be considered “overbought” and “oversold,” but caution must be exercised here as more naturally volatile securities may achieve these thresholds more frequently than usual, and as an unbounded indicator there are no upside or downside limits to CCI.

In the last few decades since Lambert’s original interpretation, other analysts have proposed alternative or additional signals from the CCI, such as for example a bullish signal when CCI is below -100 and turns upward and a bearish signal when CCI is above +100 and turns downward (i.e. using CCI to look for reversals in price action).

As is the case with technical analysis in general, the choice of which signals are preferred or accepted over others is entirely a matter of individual preference; StockSweeper tracks a variety of different interpretations of a 20-day CCI for the user’s convenience.

Longer-period CCIs may be included in StockSweeper at a future time.