Overview

A characteristic of a healthy bull market is that it makes higher-highs and higher-lows. This indicates a continual upward shift in expectations and the supply/demand lines. The amount that prices retreat following a higher-high can be measured using a technique referred to as "percent retracement." This measures the percentage that prices "retraced" from the high to the low.

For example, if a stock moves from a low of 50 to a high of 100 and then retraces to 75, the move from 100 to 75 (25 points) retraced 50% of the original move from 50 to 100.

Interpretation

Measuring the percent retracement can be helpful when determining the price levels at which prices will reverse and continue upward. During a vigorous bull market, prices often retrace up to 33% of the original move. It is not uncommon for prices to retrace up to 50%. Retracements of more than 66% almost always signify an end to the bull market.

Some investors feel that the similarities between 33%, 50%, and 66% and the Fibonacci numbersof 38.2%, 50%, and 61.8% are significant. These investors will use Fibonacci Levels to view retracement levels.

Example

I labeled the following chart of Great Western at three points (labeled "A," "B," and "C").

These points define the price before the price move ("A"), at the end of the price move ("B"), and at the retraced price ("C"). In this example, prices have retraced 61.5% of the original price move.

Overview

The Parabolic Time/Price System, developed by Welles Wilder, is used to set trailing price stops and is usually referred to as the "SAR" (stop-and-reversal). This indicator is explained thoroughly in Wilder's book, New Concepts in Technical Trading Systems.

Interpretation

The Parabolic SAR provides excellent exit points. You should close long positions when the price falls below the SAR and close short positions when the price rises above the SAR.

If you are long (i.e., the price is above the SAR), the SAR will move up every day, regardless of the direction the price is moving. The amount the SAR moves up depends on the amount that prices move.

Example

The following chart shows Compaq and its Parabolic SAR.

The Parabolic SAR is plotted as shown in Wilder's book. Each SAR stop level point is displayed on the day in which it is in effect. Note that the SAR value is today's, not tomorrow's stop level.

Calculation

It is beyond the scope of this book to explain the calculation of the Parabolic SAR. Refer to Wilder's book New Concepts in Technical Trading, for detailed calculation information.

Overview

The Money Flow Index ("MFI") is a momentum indicator that measures the strength of money flowing in and out of a security. It is related to the Relative Strength Index, but where the RSI only incorporates prices, the Money Flow Index accounts for volume.

Interpretation

The interpretation of the Money Flow Index is as follows:

• Look for divergence between the indicator and the price action. If the price trends higher and the MFI trends lower (or vice versa), a reversal may be imminent.
• Look for market tops to occur when the MFI is above 80. Look for market bottoms to occur when the MFI is below 20.

Example

The following chart shows Intel and its 14-day Money Flow Index.

Divergences at points "A" and "B" provided leading indications of the reversals that followed.

Calculation

The Money Flow Index requires a series of calculations. First, the period's Typical Price is calculated.

Next, Money Flow (not the Money Flow Index) is calculated by multiplying the period's Typical Price by the volume.

If today's Typical Price is greater than yesterday's Typical Price, it is considered Positive Money Flow. If today's price is less, it is considered Negative Money Flow.

Positive Money Flow is the sum of the Positive Money over the specified number of periods. Negative Money Flow is the sum of the Negative Money over the specified number of periods.

The Money Ratio is then calculated by dividing the Positive Money Flow by the Negative Money Flow.

Finally, the Money Flow Index is calculated using the Money Ratio.