The input variables in the study include a total of 61 variables including technical indicators in stock market and futures market and the macroeconomic indicators in Taiwan. 20 Technical indicators are used in this research as input variables. 9 popular technical indicators’s formulas and explain are shown as below[26]:
1. On balance volume(OBV):
The On Balance Volume (OBV) indicator, developed by Joe Granville, measures the strength of the prevailing trend and provides alerts to possible breakouts. OBV is calculated as continuous consecutive sum of volumes. If the current period's close is higher than the previous period's close, the current period's volume is added to the previous period's OBV. On the other hand, if the current period's close is lower than the previous period's close, the current period's volume is subtracted from the previous period's OBV. An unchanged close is neither added nor subtracted from the OBV value.
The formula for the OBV indicator is:
The OBV shows upward momentum if the new high or low is greater than the previous one. On the other hand, downward momentum is evident if the new high or low is lower than the previous one. A change from upward to downward momentum signals implies a trend reversal maybe on the horizon. If the OBV stagnates for more than 3 periods, it is considered to be in a sideways market and the previous trend has changed from either bullish or bearish to neutral.
2. Momentum(MTM)
The Momentum indicator seeks to predict future trends on recent price and volume action.
It is currently one of the most widely used technical studies because it is easy to calculate and it can be applied in a number of different ways.
The formula for the Momentum indicator is:
Momentum is an oscillator-type indicator used to detect overbought and oversold conditions and to perform as a gauge indicating the strength of the current trend.
Momentum calculations are either positive or negative and fluctuate around a zero-line.
When momentum is above the zero-line and rising, prices are increasing at an increasing rate. If momentum is above the zero line but is declining, prices are still increasing but at a decreasing rate.
On the other hand, when momentum is below the zero-line and falling, prices are decreasing at an increasing rate. If momentum is below the zero line but is rising, prices are still declining but at a decreasing rate.
With the momentum indicator, traders usually enter the market when the momentum crosses over the zero-line from negative territory and exit the market when the momentum crosses over the zero-line from positive territory.
3. Relative strength index(RSI):
The Relative Strength Index (RSI), developed by Welles Wilder, is a special form of the Momentum indicator and measures an instrument's internal strength compared to past prices. The calculation of the RSI takes a few of steps. First, positive closing prices (i.e.
positive day change) and negative closing prices (i.e. negative day change) are added and then divided by the number of periods less then one. The result is the period's mean value of upward and downward strength of the underlying instrument. The relative strength is then derived from a ratio of the upward and downward mean.
The formula for the RSI is:
The RSI fluctuates between the values of 0 to 100. A high RSI, readings over 70, suggests an overbought or weakening rally, but does not necessarily mean a top.
Conversely, a low RSI, below 30, implies an oversold market or weakening sell-off, but
does not necessarily imply a market bottom. A 50 reading can serve as a zero-line in other oscillators. Crossing the line from above or below can serve as a signal to enter the market.
Divergence can also be implied by the RSI. For example, the market makes new highs during a rally but the RSI fails to exceed its previous highs. This may indicate weakening of the rally.
4. Moving average convergence and divergence(MACD)
The Moving Average Convergence Divergence (MACD), developed by Gerald Appel, is both an oscillator and a trend indicator. It is the difference between a fast Exponential Moving Average (EMA) and a slow Exponential Moving Average and the fast Moving Average is continually converging towards or diverging away from the slow Moving Average. A third Exponential Moving Average, or signal line, is then plotted to identify changes in trends and market sentiment.
The formula for the MACD is:
The MACD study can be used to identify buy and sell signals. When the MACD crosses above the signal line, it may be time for the longs to enter the market, whereas
when a cross below the signal line occurs, it may be time for the shorts to enter the market.
The MACD study can also be used as an oscillator, an indicator that fluctuates above and below a zero-line, to signal overbought and oversold conditions. When both lines are below zero, it is considered an oversold condition, signalling a buying opportunity, whereas if both lines are above zero, it is considered an overbought condition, signalling a selling opportunity.
Divergence can also be identified with the MACD. A positive divergence occurs when the price is making new lows while the MACD fail to reach new lows. On the other hand, negative divergence occurs when the price is making new highs without being accompanied by new highs from the MACD.
5. Exponential Moving Average(EMA)
The Exponential Moving Average (EMA) finds the average price of a security over a set number of periods. It gives more weight to the more recent prices, relative to older prices, in an attempt to reduce the lag associated with moving averages, in general. The weighting applied depends on the length of the moving average specified. The shorter the EMA is, the more weight that will be applied to the most recent price. The oldest price data in the EMA is never removed, but they have only a minimal impact on the EMA.
The formula for the EMA is:
6. Williams(WMS)
The Williams' %R, developed by Larry Williams, is used to measure whether or not a security is overbought or oversold. The indicator is designed to show the relationship between the period high and the current close within the specified period. The %R is plotted on an upside down scale with 0 at the top and -100 at the bottom.
The formula for the %R is:
Traders usually consider values -20 or higher to be overbought and values -80 and under oversold. Note that the price can remain overbought, or oversold, for a long period of time even though the price continues to rise or fall.
7. Moving average(MA)
A Moving Average (MA) finds the average price of a security over a set number of periods. The calculation of the MA is like the name suggests, simple. The mean of the underlying financial instrument is calculated over a period of time. Prices during this period area are added and then divided by the total number of time periods. Every bar is thus given the same weighting.
The formula for the MA is:
Most traders use the MA as a crossover trading system. Two MAs are plotted and the shorter period MA is used as the signal line. For example, if the shorter period MA crosses over the longer period MA from below to above, then it is considered bullish and a buy opportunity. Conversely, if the shorter period MA crosses over the longer period from above to below, then it is considered bearish and a sell opportunity.
The MA is also used as a support and resistance level. If the price moves away from the MA and retraces back, more often than not, the MA will prove to be a strong support or resistance, depending on the prevailing trend. Note that only certain common MAs can be used for this purpose. 50 and 200 bars are commonly used to measure support and resistance.
8. Advance decline ratio(ADR)
The Advance/Decline Ratio (A/D Ratio) is the number of advancing issues divided by the number of declining issues. This makes it similar to the Advancing/Declining Issues - it shows market breadth (strength). The fact that a division is used, however, makes it independent of the number of issues in total (which has increased steadily over the years).
Often, a moving average of the A/D Ratio is used to indicate an overbought/oversold condition - high values mean a rally is 'overdone' and likely to adjust. In the same way, low readings mean an oversold market with a rally on the way.
The formula for the ADR is:
ADR FORMULA
(The number of issues in a market or index that have increased in price) /( the number of issues that decline in price)
9. Demand Index(DI)
Demand Index, DI, incorporates price and volume to give a ratio of buying pressure to selling pressure. DI is charted on an open scale and fluctuates above and below a zero line. When buying pressure is greater than selling pressure, the DI is above the zero line and vice versa. DI is one of the early volume indicators, developed in the 1970s by James Sibbet.
Many experienced traders feel that weekly studies can be particularly important in identifying the predominant trend, and DI is often assessed using weekly data.
The formula for the DI is:
DI FORMULA
(highest index + lowest index+2*close index)/4