Module 2   Technical AnalysisChapter 20

Supplementary Notes 1

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Average Directional Index (ADX)

About:
The Average Directional Index (ADX), Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI) represent a group of directional movement indicators that form a trading system developed by Welles Wilder. The Average Directional Index (ADX) measures trend strength without regard to trend direction. The other two indicators, Plus Directional Indicator (+DI) and Minus Directional Indicator (-DI), complement ADX by defining trend direction. Used together, chartists can determine both the direction and strength of the trend. Source: stockcharts.com

What should you know?

  1. ADX system has three components – ADX, +DI, and -DI
  2. ADX is used to measure the strength/weakness of the trend and not the actual direction
  3. ADX above 25 indicates that the present trend is strong, ADX below 20 suggest that the trend lacks strength. ADX between 20 and 25 is a grey area
  4. A buy signal is generated when ADX is 25 and the +DI crosses over –DI
  5. A sell signal is generated when ADX is 25 and the –DI crosses over +DI
  6. Once the buy or sell signal is generated, take the trade by defining the stop loss
  7. The stop loss is usually the low of the signal candle (for buy signals) and the high of the signal candles ( for short signals)
  8. The trade stays valid till the stoploss is breached (even if the +DI and –DI reverses the crossover)
  9. The default look back period for ADX is 14 days

On Kite:
Load the ADX indicator from studies. Kite gives you an option to change the look back period, by default the look back period is set

Image 1_ADX

You can customize the color of all the three components of the ADX system. Click on ‘create’ to load the indicator –

Image 2_ADX_loaded

By default the ADX indicator is loaded below the instrument. The black line represents ADX, ensure it is above 25 while looking for the crossovers.

Alligator Indicator

About:
An indicator designed to signal a trend absence, formation and direction. Bill Williams saw the alligator’s behavior as an allegory of the market’s one: the resting phase is turning into the price-hunting as the alligator awakes so that to come back to sleep after the feeding is over. The longer the alligator is sleeping the hungrier it gets and the stronger the market move will be. Source: infimarkets.com

What should you know?

  1. The Alligator indicator is overlaid on the price chart
  2. The indicator is made up of three simple moving averages – 13, 8, and 5 period averages are used
  3. The 13 period MA refers to the Alligator’s jaw, 8 period MA refers to the Alligator’s teeth, and the 5 period MA refers to the Alligator’s lips
  4. By default 13 MA is colored blue, 8 MA is colored red, and 5 MA is colored green
  5. A buy signal is generated when the following condition is satisfied –
    1. All three MA’s are separated
    2. The price is above the 5MA, 5MA is above 8MA, and 8MA is above 13 MA
    3. Once the above condition is satisfied, it means that the asset is trending up
    4. When the uptrend is established, it is upto the trader to identify a good entry point within this trend
  6. A sell signal is generated when the following condition is satisfied –
    1. All three MA’s are separated
    2. The price is below the 5MA, 5MA is below 8MA, and 8MA is below 13 MA
    3. Once the above condition is satisfied, it means that the asset is trending down
    4. When the downtrend is established, it is upto the trader to identify a good entry point within this trend
  7. Periods when the 13, 8, and 5 MA are intervened (or moving flat) is considered a ‘no trader’ zone and therefore the trader is advised to stay out of markets

On Kite:
Load the Alligator indicator from the studies. As you can see the default values of the moving averages are loaded i.e 13, 8, and 5.

Image 3_Aligator_load

As you can see, the indicator input also loads the ‘offset’ values for each MA. These offset values are also loaded by default values. Offsetting or displacing the moving average reduces the number of whipsaws in the average. Needless to say that you can change the default values for moving average and offset to any value that you deem appropriate. Further you can even customize the color of each indicator to your preference.

Here is the snapshot of how the indicator looks when the indicator is overlaid on the chart. Do notice there are 2 instances when the sell condition is satisfied (highlighted in red) and 1 instance when the buy condition is satisfied (highlighted in blue).

Image 4_aligator overlay

Aroon

About:
Developed by Tushar Chande in 1995, Aroon is an indicator system that determines whether a stock is trending or not and how strong the trend is. “Aroon” means “Dawn’s Early Light” in Sanskrit. Chande chose this name because the indicators are designed to reveal the beginning of a new trend. The Aroon indicators measure the number of periods since price recorded an x-day high or low. There are two separate indicators: Aroon-Up and Aroon-Down.

A 25-day Aroon-Up measures the number of days since a 25-day high. A 25-day Aroon-Down measures the number of days since a 25-day low. In this sense, the Aroon indicators are quite different from typical momentum oscillators, which focus on price relative to time. Aroon is unique because it focuses on time relative to price. Chartists can use the Aroon indicators to spot emerging trends, identify consolidations, define correction periods and anticipate reversals. Source: stockcharts.com

What should you know?

  1. The indicator measures the number of days since last high or low is made, hence the indicator is a measure of time relative to the price
  2. Aroon consists of two component – Aroon up and Aroon Down
  3. The default value for Aroon is 25 days. Aroon up measures the number of days since the last 25 day high occurred and Aroon down measures the number of days since the last 25 days low has occurred
  4. Both Aroon up and Aroon down are plotted side by side
  5. Aroon Up/Down is lower bound to zero and upper bound to 100
  6. A buy is generated when Aroon up is above 50 and Aroon low is below 30
  7. A sell is generated when Aroon down is above 50 and Aroon up is below 30

On Kite:
Here is the snapshot of the indicator when loaded from studies –

Image 5_aroon load

As you can see the default period is 14, feel free to change this to any number you wish. 14 here represent the ‘number of days’. Do remember if the period is 14, the Aroon measures the number of days since the stock made 14 days high/low.

Image 6_Aroon applied

As you can see both Aroon up and Aroon Down are plotted.

Aroon Oscillator

Aroon Oscillator is an extension of the Aroon indicator. The Aroon Oscillator measures the difference between the Aroon up and Aroon down and plots the difference in the form of an oscillator. The oscillator swings between -100 to +100, with the ‘0’ level as the center point.

The snapshot below shows the Aroon Oscillator loaded on to the chart –

Image 7_Aroon Osc

A reading above zero means that Aroon-Up is greater than Aroon-Down, which implies that prices are making new highs more recently than new lows. Conversely, readings below zero indicate that Aroon-Down is greater than Aroon-Up. This implies that prices are recording new lows more recently than new highs.

As you can see, the Aroon Oscillator is either going to be positive or negative the vast majority of the time. This makes interpretation straight-forward. Time and price favor an uptrend when the indicator is positive and a downtrend when the indicator is negative. A positive or negative threshold can be used to define the strength of the trend. For example, a surge above +50 would reflect a strong upside move, while a plunge below -50 would indicate a strong downside move. Source: stockcharts.com

Average True Range

About:
Developed by J. Welles Wilder, the Average True Range (ATR) is an indicator that measures volatility. As with most of his indicators, Wilder designed ATR with commodities and daily prices in mind. Commodities are frequently more volatile than stocks. They were are often subject to gaps and limit moves, which occur when a commodity opens up or down its maximum allowed move for the session. A volatility formula based only on the high-low range would fail to capture volatility from gap or limit moves. Wilder created Average True Range to capture this “missing” volatility. It is important to remember that ATR does not provide an indication of price direction, just volatility. Source: stockcharts.com

What should you know?

  1. Average True Range (ATR) is an extension of True Range concept
  2. ATR is not upper or lower bound, hence can take any value
  3. ATR is stock price specific, hence for Stock 1 ATR can be in the range of 1.2 and Stock 2 ATR could be in the range of 150
  4. ATR attempts to measure the volatility situation and not really the direction of the prices
  5. ATR is used to identify stop loss as well
  6. If the ATR of a stock is 48, then it means that on average the stock is likely to move 48 points either ways up or down. You can add this to the current day’s range to estimate the day’s range. For example the stock price is 1320, then the stock is likely to trade between 1320 – 48 = 1272 and 1320 + 48 = 1368
  7. If the ATR for the next day decreases to say 40, then it means that the volatility is decreasing, and so is the expected range for the day
  8. It is best to use ATR to identify the volatility based SL while trading. Assume you have initiated a long trade on the stock at 1325, then your SL should be at least 1272 or below since the ATR is 48
  9. Likewise if you have initiated a short at 1320, then your stoploss should be at least 1368 or above
  10. If these SL levels are outside your risk to reward appetite, the its best to avoid such trade.

On Kite:
As you can see, the default value of ATR is 14, which means to say that the system calculates the ATR for the last 14 days. Of course you can change this to any value to wish. Here is the snapshot –

Image 8_ATR_load

Once you load the chart, ATR is plotted below the price chart as seen below –

Image 9_ATR_create

So the next time you place a stoploss make sure you check the ATR value to see if stoploss level is relevant. You may also want to read more about volatility and its application (including volatility based SL) – Click Here

Average True Range Band

The ATR bands are an extension of the ATR concept. The idea is to plot an envelope around the stock price to evaluate if the stock prices are behaving “normally” or trending in a particular direction. In order to do this, the ATR band calculates the upper and lower band.

What should you know?

  1. The ATR band calculates and plots the upper and lower envelope around the stock price
  2. To begin with a moving average of stock price is calculated
  3. The ATR value is added to the moving average value, and this forms the upper envelop
  4. The ATR value is subtracted to the moving average value, and this forms the lower envelop
  5. If the stock price penetrates either the upper or lower envelop, then the expectation is that the stock price will continue to move in the same direction. For example if the stock price has penetrated above the upper envelop, the expectation is that the stock will continue to move higher
  6. You can even use the ATR bands as an alternate to the Bollinger Band trading system. You can read more about the Bollinger Band (section 15.2)

On Kite:
When you load the ATR band from studies, you will be prompted for few inputs –

Image 10_ATRB_load

Period refers to the MA time frame; the default value is 5 days. You can change this to whichever time frame that you deem suitable. We would suggest you ignore ‘shift’ parameter. For the ‘field’ option select ‘close’, this means to say that you are plotting the MA values on the closing prices. The rest of the options are mainly aesthetic features, feel free to explore them. Once you click create, you will see the ATR bands plotted on the chart.

Image 11_ATRbands_created

Super trend

Before understanding the supertrend indicator, understanding the ATR is necessary as super trend employs ATR values to calculate the indicator values. The supertrend indicator is plotted over the price chart of the stock or the index. The indicator line changes its color between green and red based on the price moment in the underlying. Super trend does not predict the direction, rather once the direction is established it will guide you to initiate a position and suggests you to stay in the position till the trend sustains.

What should you know?

  1. When plotted, the supertrend indicator appears like a alternating green and red continuous line
  2. A buy signal is generated when the stock/index price turns greater than the indicator value. At this stage, the indicator color turn green and you can also see a crossover of the price versus the indicator (price greater than indicator value)
  3. Once the long position has been established, the trader is advised to hold the position till the price closes below the green line. So in a sense the green line helps as a trailing stoploss for the long position
  4. A sell signal is generated when the stock/index price turns lesser than the indicator value. At this stage, the indicator color turn red and you can also see a crossover of the price versus the indicator (price lesser than indicator value)
  5. The sell signal can be used to initiate a fresh short or exit long. Although waiting for the sell signal to exit the existing long position can sometime lead to taking a loss. So the trader should use his discretion here
  6. Once the short position has been established, the trader is advised to hold the position till the price closes below the green line. So in a sense the red line helps as a trailing stoploss for the short position
  7. Supertrend is basically used to identify a trend therefore it works best in a trending market
  8. The supertrend indicator when compared to a regular Moving Average trading system generates fewer false signals, for this reason the super trend indicator is preferred over a Moving Average trading system

On Kite:
When you select Supertrend indicator from the list of studies you will be prompted for two inputs – Period and Multiplier.

Image 12_supertrend load

Period refers to the ATR number of days. The default value on Kite is 7, which means to say that the system will calculate the ATR value for the last 7 days. You can input any value you deem suitable.

The multiplier refers to a value by which the ATR will get multiplied. The default value on Kite is 3, so whatever is the value of ATR, it will get multiplied by 3. Multiplier is a crucial input for Super trend. If the multiplier value is too high, then lesser number of signals are generated. Likewise if the multiplier value is too small, then the frequency of signals increase, hence chances of generating false trading signals are quite high. I would suggest you keep this value between 3 and 4.

Once the indicator is plotted, this is how it appears on the chart –

Image 13_supertrend_create

Notice how the indicator changes the color as the price moves. Also, whenever the buy/sell signal is generated green and red arrows are generated (respectively) prompting the trader to go long or short on the stock.

Volume weighted average price (VWAP)

VWAP is one of the one of the simplest indicators to use. It works on the principle of averaging the traded price in terms of volume traded. Let me give you an example of to help you understand this better.

Here is how Infy traded between 14:30 and 14:35 on 2nd Nov 2016 –

image-14_vwap

The data is quite simple to understand, for example, at 14:32, 2475 shares were traded, it made a high of 983.95, low of 983, and closed the minute at 983.1.

Now, we use this data and compute the VWAP price. In order to do this, we calculate the following –

  1. Typical price = which is the average price of High, Low, and close
  2. Volume Price (VP) = we get this by multiplying the typical price with its volume
  3. Total VP = This is a cumulative number, which is got by adding the current VP to the previous VP
  4. Total volume = This is again a cumulative number, which is got by adding the current volume to the previous volume
  5. VWAP = We get this VWAP number by dividing the Total VP by Total Volume. The resulting number indicates the average traded price, weighted by volume.

Let’s do the math on Infy data –

image-15_vwap

As you see, the VWAP is a dynamic number, changing based on how the trades flow in.

How to use the VWAP?

  1. VWAP is an intraday indicator, use it on minute charts. Often when you plot this, you will notice a jump at 9:15 AM, when compared to previous day’s data. Ignore this jump as it means nothing
  2. VWAP is an average and like any indicators employing averages, this too lags the current market price
  3. VWAP is used for 2 main reasons – to get a sense of intraday direction and to get a sense of the efficiency of order execution
  4. If the current price is below VWAP, then the general opinion is that the intraday trend is down
  5. If the current price is above VWAP, then the general opinion is that the stock is trending higher
  6. If the VWAP lies in between the high and low, then the expectation is that the stock will remain volatile
  7. If you intend to short a stock, then it is considered an efficient fill if you short the stock at a price higher than VWAP
  8. Likewise, if you intend to go long on a stock, then it is considered an efficient fill if you go long at a price lower than VWAP

On Kite:

Open the chart of your preference and select VWAP from the studies drop down –

image-16_vwap

Note, VWAP can be applied only on intraday time frame and cannot be applied on EOD data.

Once you select the time frame (1 min, 5 mins, 10 mins etc), the engine calculates the VWAP and plots it on the chart as an overlay.

image-17_vwap

You can now visualize the VWAP and the current market price and plan your trades accordingly.

 

972 comments

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  1. Adam says:

    In the supertrend example, if we would have waited for crossovers to exit, we would have suffered losses(or at least would have lost most of our profits) so is there a better exiting strategy?

    • Karthik Rangappa says:

      Maybe in this case, but generally speaking the indicator allows you to capture a chunk of the trend. Larger the trend, higher the number of points you can capture.

      • sathish says:

        Changing the components colour is possible?In above screenshots green,red widely used how can i on kite?

        • Karthik Rangappa says:

          You can explore the themes in Kite and select colours based on your preference.

          • Devashish says:

            Supertrend in Zerodha works on close basis. Is there a possiblity of introducing Supertrend on HIgh/ Low basis ? Since stops etc ultimately get triggered on levels determined by actual high/ lows and not close

            thanks

          • Karthik Rangappa says:

            Not sure if this can be done, Devashish. The indicators come from 3rd party sources and I believe they are hard coded. Let me check this though.

    • limesh mishra says:

      hey adam
      a would suggest you just take a target of 0.5 rs thats it and trade multiple times rather than trying to generate a big profit from a single trade

  2. Vipul Karde says:

    I think Super Trend is the best indicator or what I would say as super Profit machine. We should see first identify the 30 min Super Trend Signal – whether buy or sell and then see 5 min Super Trend signal line to enter the trade as per the 30 min Signal. Eg. if 30 min signal is in sell mode (red line above), then in 5 min mode take every sell signal that comes with stoploss of 5 min signal line. I have minted tons with this strategy hence sharing. Karthik Sir can elaborate further if there are any chinks in this strategy. Alternatively you may combine any longer term time frame to judge primary trend and take decision as per shorter time frame supertrend eg. 1 hr – 10 mins 🙂 Thank you

    • Khyati Verdhan says:

      Hi vipul
      Your strategy is good and works well in trending and low volatile market but in range bound market with high volatility it sometime fails. So I feel if we combine it with some other indicators like donchain channel, SMI, the result would be far more better.

    • Karthik Rangappa says:

      Vipul, if the strategy is working fine with you, then best not to tamper with it 🙂

    • ShreyaDR says:

      Vipul, do you mean keep on averaging >>if 30 min signal is in sell mode (red line above), then in 5 min mode take every sell signal that comes with stoploss of 5 min signal line>>

      • Vipul Karde says:

        First of all thanks to Karthik sir for his guidance & khyatiji for appraisal. What i meant by this strategy was take every long term signal i.e buy or sell signal on 30 min chart. In case of 5 min duration enter and exit as per 5 min chart signal. Please dont average especially in case of options it may not work due to decay in premiums. I normally believe in booking timely profits hence not encouraging average stuff.. all the best. 🙂

        • Karthik Rangappa says:

          Just to add – averaging on your losing trade is not advisable at all. On the other hand, one should look at averaging on winners.

        • Dileep says:

          What happens when Sell signal appears in 5 mins chart after you have entered into trade looking at buy signal in both 30 mins and then 5 mins. Are you going to square off buy trade or keep it open until new signal appears in 30 mins chart?

          • Karthik Rangappa says:

            You should go with the primary time frame – if the decision was based on 30 mins, then its best to stick to the 30 mins time frame.

          • Dileep says:

            I have tried it but failed badly. lost 27490 in a single trade. It does not give signal in correct direction. nothing is guaranteed.

          • Karthik Rangappa says:

            Absolutely, nothing is a guarantee. The only thing that comes close is constant learning and improvisation.

          • Vipul Karde says:

            Felt sorry for the losses that you incurred. See basically my ideology is take all the primary time frame & trend signal & in case you have missed it then switch to lower timeframe and take the signals equivalent to primary time frame. Hope not confusing ! Also you should have defined risk taking & risk management discipline planned in advance only before trade entry.
            As Karthik Sir mentioned that in the market you might be equipped by numerous tools, but dont take anything for granted & guaranteed. Proper Trade Discipline & Stoploss would always save the skin. Nevertheless you can always cover up your losses. Don’t be disheartened. 🙂

          • Dileep says:

            What I have observed over a period of time, what signal Supertrend gives after 10-15 minutes, the same signal appears in Parabolic SAR 10-15 minutes before. SO you will certainly get much better price than Supertrend. So far, PSAR has been the best indicator ever I have come across.

          • Dileep says:

            As far as accuracy is concerned, Both Supertrend and PSAR will give same accuracy. But you can catch more points in PSAR.

        • ShreyaDR says:

          Vipul, when you say “timely profit” and since you trade intraday, can you pls. explain your strategy, with the help of charts ( flashback feature from Q)? how & when you book ur profit or how & when you book ur losses?

          • Shiva nand Mishra says:

            Sir what is PSAR which is like super trend indicator.
            Please reply

          • Karthik Rangappa says:

            Parabolic SAR or PSAR is a series of dots placed above and below the price of the stock, indicating buy and sell trades. This is a momentum indicator. It is much less complicated compared to a supertrend.

    • Gaurav says:

      Try to use Heikin Ashi chart and then use your strategy. Test this on some previous data, and tell if it gives better signals.

    • Sutharsan Shanmugasundaram says:

      Vipul – while using 5 mins time frame, do you close out each day before 3:30 PM ? Because I think overnight position could be very dangerous for short time frames.

    • chandramouli says:

      Mr. Vipul, could you please elaborate the logic of identifying the signal on 30 min time frame and then placing a stop loss on the 5 min candle

    • anand says:

      I did not understand how to use supertrend signal .
      how long to wait for going long on the stock if signal shows green crossover .
      what should be target and stoploss when using supertrend signal .

      • Karthik Rangappa says:

        Anand, have discussed supertrend in detail in the note including all the questions you’ve asked. Suggest you give it another read, thanks.

    • Raviraj says:

      What is the target

    • Anish says:

      Thank you Vipul for this strategy.

  3. Lijoo says:

    Sir, What is SMI & Donchain Channel ?. Is it available in pi an in kite ?. Can you elaborate both ?.

    DL 0071

  4. Khyati Verdhan says:

    Hi kartik
    Thanks for this supplement notes on indicators. It is very useful and knowledge gaining too. Will you give such description on other indicators and chart pattern on kite, it would be very helpful. Also. Kite app can also contain all features of web based platform??

  5. ShreyaDR says:

    gr8 article. Can you please explain types of charts & its utilization too? i.e. heiken Ashi, point & figure, range bars, Renko etc.

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