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Stocks & Commodities V. 12:5 (211-214): Breadth Stix And Other Tricks

Breadth STIX And Other Tricks

Interested in advance-decline indicators? Well, you're in luck. Here, STOCKS & COMMODITIES contributor Tushar Chande reviews popular versions of these indicators and explains that since they are all derived from the same raw data, they have certain similarities. Chande explains how to derive a stochastic oscillator from market breadth data for market timing.

by Tushar Chande

The daily number of advancing issues (ADI) and the daily number of declining issues (DCI) are two items of data unique to the stock market. Technical analysts have developed a variety of ways to analyze this data. Strong similarities exist between these approaches, not surprising, considering they use the same raw data. But none is completely like another, and so you can use the indicator that best suits your trading style.

VARIETY 'S THE SPICE

The ADI and DCI data can be analyzed in a number of ways, a few of which are summarized in Figure 1. You could find other combinations as well. The simplest approaches, of course, would be to look at the ADI and DCI by themselves, or use the difference of two moving averages of the ADI or DCI to form an oscillator or take the daily difference between ADI and DCI. Let us call this the daily difference of issues (DDI = ADI - DCI). You can now take the difference in the moving averages of the DDI to give yet another net difference oscillator.

You can also define ratios using ADI and DCI, using any of the following ratios. These indicators can be used to identify two sets of conditions overbought/oversold situations, and the trend of the broad market.

A number of popular indicators can be identified in Figure 1. STIX is a short-term trading index that is a 21-day (9%) moving average of the ADI index:

Article Text 1Copyright (c) Technical Analysis Inc.

Copyright (c) Technical Analysis Inc.

FIGURE 2: THE S&P 500 AND STIX, APRIL TO NOVEMBER 1993. Look at the broad similarities. Here, the STIXindicator and the Standard & Poors 500 index from mid- to late 1993 can be seen. Peaks and valleysin the indicator occur at the same time as those in the market index. The market was overbought inSeptember with a STIX value above 54.

DIFFERENT WAYS OF USING ADI AND DCI DATA

ADI and its 19-day exponential moving average

DCI and its 19-day exponential moving averageADI oscillator = short moving average - long moving average

= (19-day exponential) - (38-day exponential)DCI oscillator = (19-day exponential) - (38-day exponential)

DDI = (ADI - DCI)DDI and its 10-day exponential moving averageDDI oscillator = (19-day exponential) - (38-day exponential)

A/D ratio = ADI/DCIA/D ratio and its 21-day exponential moving average

ADI index = ADI/(ADI+DCI)ADI index and its 10-day exponential moving average

DDI index = (ADI-DCI)/(ADI+DCI)Cumulative DDI indexStochastic of the cumulative DDI index

FIGURE 1: The ADI and DCI data can be analyzed in anumber of ways, a few of which are summarized here.


ADI index = (ADI/(ADI+DCI)) 100

STIXtoday = (0.09)(ADI index) + (0.91)(STIXyesterday)

STIX usually ranges between +42 and +58 and can be used to define overbought or oversold levels. These are general guidelines and you may wish to develop action levels of your own.

The McClellan oscillator is the difference between 19-day and 39-day exponential moving averages of ADI-DCI, and hence, it is an oscillator of the DDI. The market is considered overbought in the +70 to +100 area and oversold in the -70 to -100 area; it is similar to STIX in that both use the same raw data.

The breadth thrust indicator is a 10-day exponential moving average of the ADI index. Bull markets often start with an explosive rally that pushes this indicator to over the 60% level within a two-week period.

Bull markets often start with an explosive rally that pushes the ADI index to over the 60% level within a two-week period.

INDICATOR SIMILARITIES

Now look at the broad similarities among these indicators. Figure 2 shows the STIX indicator and the Standard & Poor's 500 index from mid- to late 1993. Peaks and valleys in the indicator occur at the same time as those in the market index. The market was overbought in September with a STIX value above 54.

Figure 3 shows the McClellan oscillator and the S&P 500 index for the same period as Figure 2. This indicator did not reach an overbought condition during this period, though it reached an oversold condition in early November. Note the broad similarity to the STIX indicator. The McClellan oscillator (lower graph) and STIX (upper graph) can be directly compared in Figure 4. Both indicators seem to turn together; there are slight differences due to the way each is calculated and smoothed.

Or consider the OB/OS indicator, which is a 10-day exponential moving average of DDI. It can be seen in Figure 5 with the S&P 500 index for the same period as in Figure 2. In this indicator, the market is considered overbought when values are above +200 and the market is considered oversold when values dip under -200. This OB/OS indicator correctly called the oversold condition in April, June, September and November 1993. It also called the overbought condition in late August of the same year. You can compare the similarities between the OB/OS indicator and STIX (upper graph) in Figure 6.

PRECISION CORRELATION

Do ADI and DCI data correlate precisely with price action? There is a broad correspondence between ADI/DCI and price action. However, the relationship is neither exact nor constant. Let us use the DDI index to probe this question. As can be seen in Figure 1:

DDI Index = ((ADI-DCI)/(ADI+DCI))

Here, I have included both the ADI and DCI to give equal impact for up and down markets. I will cumulate the daily DDI value and compare it with market action in Figure 7. In general, the cumulative DDI index ascends when the market is rising and falls when the market is declining; however, there are subtle differences on a day-to-day basis. For example, the cumulative DDI index can ascend even when

Article Text 2Copyright (c) Technical Analysis Inc.


FIGURE 3: THE S&P 500 AND McCLELLAN OSCILLATOR, APRIL TO NOVEMBER 1993. Here, the McClellanoscillator and the S&P 500 index for the same period as Figure 2 can be seen. This indicator did notreach an overbought condition during this period, though it reached an oversold condition in earlyNovember. Note the broad similarity to the STIX indicator.

FIGURE 4: STIX AND McCLELLAN OSCILLATOR. Here, the McClellan oscillator (lower graph) and STIX (uppergraph) can be directly compared. Both indicators seem to turn together; there are slight differences dueto the way each is calculated and smoothed.


FIGURE 5: S&P 500 AND OVERBOUGHT/OVERSOLD INDICATOR, APRIL TO NOVEMBER 1993. Consider the OB/OSindicator, which is a 10-day exponential moving average of DDI. The market is considered overboughtwhen values are above +200 and considered oversold when values dip under -200. This indicatorcorrectly called the oversold condition in April, June, September and November 1993 and also calledthe overbought condition in late August.

FIGURE 6: STIX AND OB/OS. Here, the similarities between the OB/OS indicator and STIX (upper graph)can be compared.


FIGURE 7: S&P 500 AND MARKET. Here, the daily DDI value is compared with market action. In general,the cumulative DDI index ascends when the market is rising and falls when the market is declining;however, there are subtle differences on a day-to-day basis. For example, the cumulative DDI indexcan ascend even when the market is locked in a narrow trading range. For example, check out the July-August or September-October periods in 1993.

FIGURE 8: MARKET AND 5%K STOCHASTIC. Here, a five-day stochastic oscillator of the cumulative DDIindex can be seen. The stochastic oscillator shows extremes in the cumulative DDI index.


the market is locked in a narrow trading range. For example, check out the July-August or September-October periods in 1993.

Take a closer look at price action and the cumulative DDI index by converting the cumulative DDI index into a stochastic oscillator:

DDIDDI DDI

DDI DDI period StochasticH Today

H L5

5

5 5

100=

In Figure 8, you can see a five-day stochastic oscillator of the cumulative DDI index. The stochastic oscillator shows extremes in the cumulative DDI index. I have replotted the S&P 500 index under the stochastic oscillator in Figure 9. I then used a 80/20 stochastic crossover rule to mark buy and sell signals. The arrows often provide good entry and exit signals. This shows that the cumulative DDI index is usually synchronized with price action of a broad stock market index. Aggressive traders could use values of 100 and zero as early warnings of price reversals.

END RESULT

Many different indicators use the raw ADI and DCI data including the popular McClellan oscillator, STIX, breadth thrust and OB/OS indicators. These indicators all have strong similarities. You can convert the cumulative DDI index into a stochastic oscillator to identify market extremes. Your choice of breadth indicator will depend on your trading horizon.

Tushar Chande, CTA, holds a doctorate in engineering from the University of Illinois and a master's degree in business administration from the University of Pittsburgh.

Figures 3Copyright (c) Technical Analysis Inc.


FIGURE 9: S&P 500 AND 5%K STOCHASTIC. Here, the S&P 500 index has been replotted under thestochastic oscillator. A 80/20 stochastic crossover rule was used to mark buy and sell signals. Thearrows often provide good entry and exit signals. This shows that the cumulative DDI index is usuallysynchronized with price action of a broad stock market index. Aggressive traders could use values of100 and zero as early warnings of price reversals.

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