Technical analysis: AEX Index-Amsterdam (^AEX)

Relative strength index (RSI)

The Relative Strength Index is a technical analysis oscillator showing price strength by comparing upward and downward close-to-close movements. The RSI is popular because it is relatively easy to interpret. It was developed by J. Welles Wilder and published in Commodities magazine (now called Futures magazine) in June 1978, and in his New Concepts in Technical Trading Systems the same year.

Interpretation

Wilder recommended a smoothing period of N=14. Wilder considered a security overbought if it reached the 70 level, meaning that the speculator should consider selling. Or conversely oversold at the 30 level. The principle is that when there's a high proportion of daily movement in one direction it suggests an extreme, and prices are likely to reverse. Levels 80 and 20 are also used, or may be varied according to market conditions (eg. a bull market may have an upward bias). Large surges and drops in securities will affect RSI, but it could just be a false buy or sell. The RSI is best used as a complement with other technical analysis indicators.

Source: Wikipedia

Exponential moving average (EMA)

An exponential moving average (EMA), sometimes also called an exponentially weighted moving average (EWMA), applies weighting factors which decrease exponentially. The weighting for each day decreases exponentially, giving much more importance to recent observations while still not discarding older observations entirely.

Source: Wikipedia

Moving Average Convergence (MACD)

MACD, which stands for Moving Average Convergence / Divergence, is a technical analysis indicator created by Gerald Appel in the 1960s. It shows the difference between a fast and slow exponential moving average (EMA) of closing prices. Fast means a short-period average, and slow means a long period one. The standard periods are 12 and 26 days.

Interpretation

MACD is a trend following indicator, and is designed to identify trend changes. It's generally not recommended for use in ranging market conditions. Three types of trading signals are generated,

• MACD line crossing the signal line.
• MACD line crossing zero
• Divergence between price and MACD levels

The signal line crossing is the usual trading rule. This is to buy when the MACD crosses up through the signal line, or sell when it crosses down through the signal line. These crossings may occur too frequently, and other tests may be needed to be applied.

A crossing of the MACD line up through zero is interpreted as bullish, or down through zero as bearish. These crossings are of course simply the original EMA(12) line crossing up or down through the slower EMA(26) line.

Positive divergence between MACD and price arises when price makes a new selloff low, but the MACD doesn't make a new low, ie. it remains above where it fell to on that previous price low. This is interpreted as bullish, suggesting the downtrend may be nearly over. Negative divergence is the same thing when rising, ie. price makes a new rally high, but MACD doesn't rise as high as it did before; this is interpreted as bearish.

Divergence may be similarly interpreted on the price versus the histogram, ie. new price levels not confirmed by new histogram levels. Longer and sharper divergences (distinct peaks or troughs) are regarded as more significant than small shallow patterns in this case.

John Murphy (in Technical Analysis of the Financial Markets) also recommended looking at a MACD on a weekly scale before looking at a daily scale, so as to avoid making short term trades against the direction of the intermediate trend.

Source: Wikipedia