Basis Point - BPS

What Does Basis Point - BPS Mean?

A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.

The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points, and 0.01% = 1 basis point.

So, a bond whose yield increases from 5% to 5.5% is said to increase by 50 basis points; or interest rates that have risen 1% are said to have increased by 100 basis points.

Accumulation/Distribution Line

Looking at the flow of money in and out of a security is one of the best ways to determine the likely directions of a security. At the most basic level, the price of a security is determined by the supply and demand for that security, which can both be illustrated by the money flow of the security.

One of the most commonly used indicators to determine the money flow of a security is the accumulation/distribution line (A/D line). It is similar to on-balance volume indicator but instead of only considering the closing price of the security for the period it also takes into account the trading range for the period. This is thought to give a more accurate picture of money flow than of balance volume.

Calculation

The first thing that is calculated is the close location value (CLV), which is a reflection of the closing price of the period relative to the range of the trading. The CLV ranges between +1 and -1, where a value of +1 means the close is equal to the high and the value of -1 means the close was the low. When the CLV is equal to zero, it means that price closed exactly halfway between the high and the low for the day.

The CLV value is then multiplied by the volume and similar to on-balance volume is added to a running total. By multiplying volume by the CLV, the calculation effectively weighs the money flowing in and out of the security.

The CLV is calculated as:

For example, if the high for the day was $59, the low $50, and the close was $55 the CLV would be calculated as follows:

If the volume for the trading day was 10 million shares, the amount added to the accumulation/distribution line would be +1,110,000. As can be seen this value is much different from the +10 million that would be added in the on-balance value measure.

Uses of the accumulation/distribution line

The A/D line measures the trend in the amount of buying or selling pressure in a security. When the line is trending up is a signal of increasing buying pressure as the stock is closing above the halfway point of the range. If the line is trending downward it is a signal of increasing selling pressure in the security.

This line can be used to determine the strength of a trend along with identifying divergence to signal a trend change. The strength of a price trend can be identified by looking at the direction of the trend in the A/D line. It is important that the price trend and the A/D line be trending in the same direction for the price trend to be considered strong.

The A/D line can also be used to identify situations of divergence, which can signal a shift in the price trend. This occurs when the price trend and the A/D line are moving in opposite directions.A bullish signal is formed when there is positive divergence, which means that the A/D line is trending upward while the price is trending downward. A rising A/D line signals that buying pressure is increasing, which should eventually lead to price increases. It is difficult to imagine that a price can continue to fall while buying pressure is clearly increasing.

A bearish signal is formed when there is negative divergence, which occurs when the A/D line is trending downward while the price is trending upward. A falling A/D line is a sign of selling pressure, which as it increases makes it difficult for the upward price trend to continue.

The A/D line expands on the on-balance volume measure to help technical trader's measure price and volume together and compare it against the pricing trend in the market.

The Relative Strength Index

The relative strength index (RSI) is another one of the most frequently used and well known momentum indicators in technical analysis. It is used to signal overbought and oversold conditions in a security.

The indicator is plotted between a range of zero to 100 where 100 is the highest overbought condition and zero is the highest oversold condition. The RSI helps to measure the strength of a security's recent up moves compared to the strength of its recent down moves. This helps to indicate whether a security has seen more buying or selling pressure over the trading period.

The standard calculation uses 14 trading periods as the basis for the calculation which can be adjusted to meet the needs of the user. If the trading periods used is lowered then the RSI will be more volatile and is used for shorter term trades.

Calculation

How the RSI is used

Like most indicators there are two general ways in which the indicator is used to generate signals - crossovers and divergence. In the case of the RSI, the indicator uses crossovers of its overbought, oversold and centerline.

The first technique is to use overbought and sold lines to generate buy-and-sell signals. In the RSI, the overbought line is typically set at 70 and when the RSI is above this level the security is considered to be overbought. The security is seen as oversold when the RSI is below 30. These values can be adjusted to either increase or decrease the amount of signals that are formed by the RSI.

How the RSI is used

Like most indicators there are two general ways in which the indicator is used to generate signals - crossovers and divergence. In the case of the RSI, the indicator uses crossovers of its overbought, oversold and centerline.

The first technique is to use overbought and sold lines to generate buy-and-sell signals. In the RSI, the overbought line is typically set at 70 and when the RSI is above this level the security is considered to be overbought. The security is seen as oversold when the RSI is below 30. These values can be adjusted to either increase or decrease the amount of signals that are formed by the RSI.

A buy signal is generated when the RSI breaks the oversold line in an upward direction, which means that it goes from below the oversold line to moving above it. A sell signal is formed when the RSI breaks the overbought line in a downward direction crossing from above the line to below the line. A more conservative approach can be used by setting the overbought and oversold levels at 80 and 20, respectively.

Another crossover technique used in formulating signals is using the centerline (50). This technique is exactly the same as using the overbought and oversold lines to formulate signals. This technique will often form signals after a movement in the direction they are predicting but are used more as a confirmation then a signal compared to the other techniques. A downward trend is confirmed when the RSI crosses from above 50 to below 50. An upward trend is confirmed when the RSI crosses above 50.

Divergence can be used to form signals as well. If the RSI is moving in an upward direction and the security is moving in a downward direction it signals to technical traders that buying pressure is increasing and the downtrend may be coming to an end. Divergence can also be used to signal a reversal in an upward trend where the RSI is decreasing signaling increasing selling pressure in an upward trend.

The RSI is a standard component on any basic technical chart. The relative strength indicator focuses on the momentum underlying the security and is a great secondary measure to be used by traders. It is important to note that the RSI is often not used as the sole generation of buy-and-sell signals but used in conjunction with other indicators and chart patterns.

Stochastic Oscillator

Stochastic Oscillator

What Does Stochastic Oscillator Mean?

A technical momentum indicator that compares a security's closing price to its price range over a given time period. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result. This indicator is calculated with the following formula:

%K = 100[(C - L14)/(H14 - L14)]

C = the most recent closing price

L14 = the low of the 14 previous trading sessions

H14 = the highest price traded during the same 14-day period.

%D = 3-period moving average of %K

The theory behind this indicator is that in an upward-trending market, prices tend to close near their high, and during a downward-trending market, prices tend to close near their low. Transaction signals occur when the %K crosses through a three-period moving average called the "%D".

The stochastic oscillator is another well-known momentum indicator used in technical analysis. The idea behind this indicator is that the closing prices should predominantly close in the same direction as the prevailing trend.

In an upward trend the price should be closing near the highs of the trading range and in a downward trend the price should be closing near the lows of the trading range. When this occurs it signals continued momentum and strength in the direction of the prevailing trend.

The stochastic oscillator is plotted within a range of zero and 100 and signals overbought conditions above 80 and oversold conditions below 20. The stochastic oscillator contains two lines. The first line is the %K which is essentially the raw measure used to formulate the idea of momentum behind the oscillator. The second line is the %D which is simply a moving average of the %K. The %D line is considered to be the more important of the two lines as it seen to produce better signals.

The stochastic oscillator generally uses the past 14 trading periods in the calculation but can be adjusted to meet the needs of the user.

Calculation

There are three versions of the stochastic oscillator fast, slow and full. The purpose of each version of the stochastic is to smooth the oscillator and help remove some of the randomness. The fast stochastic oscillator is the basic version of the indicator and is the one represented by the above equations. The slow and full stochastics smooth the data that is provided by the raw data given in the fast stochastic. Both of these oscillators reflect the same period and plot two lines.

Slow Stochastic:

The number of periods used in calculating the slow %D can be adjusted to meet the user’s needs.

Full Stochastic:

Stochastic Signal Generation

The main signal that is formed by this oscillator is when the %K line crosses the %D line. A bullish signal is formed when the %K breaks through the %D in an upward direction. A bearish signal is formed when the %K falls through the %D in a downward direction.

Divergence can also be used to formulate buy–and-sell signals. When looking for divergence the %D line is the one most used as it gives clearer signals due to its smoothed nature. A divergence signal is formed when the %D and the security move away from one another, signaling a weakening of the trend.

If the security is moving in an upward direction and the %D is moving in a downward direction this is a bearish sign. A bullish sign is formed when the %D is moving upward when the security is moving downward. If this divergence is happening when the %D is in an overbought (above 80) or an oversold (below 20) position on the oscillator the signal formed is much stronger. However, the signal is not considered complete until the %K line crosses the %D line in the opposite direction of the price trend.

The stochastic oscillator is a little more difficult to calculate compared to other technical indictors but none the less it is one of the more commonly used indicators. The indicator can be adjusted to any time frame but is normally set to equal 14 periods.