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Quantifying The Market Type With ROC and ATR

The document discusses quantifying market direction and volatility using the ROC% and ATR% indicators. It provides classifications for market direction (strong bull, bull, sideways, bear, strong bear) based on 63-day ROC% values and classifications for volatility (very volatile, volatile, normal, quiet) based on comparing the current 21-day ATR% to its historical mean and standard deviation. It also discusses using Keltner bands to help determine if a sideways market is trading towards the high or low end of its range. Sample trades are provided as examples.

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PRABHASH SINGH
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369 views4 pages

Quantifying The Market Type With ROC and ATR

The document discusses quantifying market direction and volatility using the ROC% and ATR% indicators. It provides classifications for market direction (strong bull, bull, sideways, bear, strong bear) based on 63-day ROC% values and classifications for volatility (very volatile, volatile, normal, quiet) based on comparing the current 21-day ATR% to its historical mean and standard deviation. It also discusses using Keltner bands to help determine if a sideways market is trading towards the high or low end of its range. Sample trades are provided as examples.

Uploaded by

PRABHASH SINGH
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Quantifying the Market Type with ROC% and ATR%

The following rules provide an idea as to how you might want to quantify both market
direction and volatility using the ROC% and Average True Range Percentage indicator.

The reason for calculating volatility with the average true range percent indicator instead of
simply the average true range, is that we want to keep the volatility measurement relative to
the price of what we’re analysing.

For example, if the S&P500 is trading at 2100 it will obviously have a higher ATR than if it’s
trading at 600. However, that doesn’t tell us anything useful about how volatile the market is
compared to its own history.

The ATR percentage indicator divides the 21 day ATR by the closing price each day and so
whether the market being analysed is at 2100 or 600, the measurement of volatility remains
relative.

For this example we’ll assume that we’re swing trading and so we set the parameters
accordingly. If we were more interested in the longer term market direction we could use the
past 200 days in our calculations.

Conversely, if we are more interested in the short term market direction we could use maybe
the past 21 days in our calculations.

Further, the exact same parameters below are applied to the SPY and then each of the 9 major
sector ETFs. These broad parameters do a reasonable job of telling us what the current
market type is for a variety of sectors.

However, you could test different parameters for each specific sector ETF that you’re
analysing to better quantify the market direction classifications for each sector.

We’ll begin by quantifying the market/sector direction. To do this we’ll use a 63 day ROC%
indicator (note that 63 trading days is roughly 3 months).

The direction will be classified as follows:

StrongBull = ROC(C,63) > 7;

Bull = ROC(C,63) > 4 AND ROC(C,63) <= 7;

Sideways = ROC(C,63) <= 4 AND ROC(C,63) > -2;

Bear = ROC(C,63) <= -2 AND ROC(C,63) >= -5;

StrongBear = ROC(C,63) <= -5;


Market/Sector Volatility
To quantify the volatility of a market we’ll use the ATR% indicator. To calculate the ATR%
indicator you simply need to divide today’s 21 day ATR by today’s closing price.

We’ll then calculate the ATR% mean and standard deviation using the past 2 years of data.

The volatility will then be classified as follows:

VeryVolatile = ATR% >= (ATR%Mean + (3*ATR%SD))

Volatile = ATR% >= (ATR%Mean + (1*ATR%SD))

Normal = ATR% < (ATR%Mean + (1*ATR%SD)) AND ATR% > (ATR%Mean -


(1*ATR%SD))

Quiet = ATR% <= (ATR%Mean - (1*ATR%SD))

Keltner Bands
Finally, when analysing a sideways market it often helps to have a quantifiable method for
determining if the price is trading towards the high or low end of a trading range.

The Keltner bands do a good job of this although you could use Bollinger bands, X day
Highs/Lows, or Overbought/Oversold oscillators.

In the following example we see a price chart of the REIT sector ETF $RWR. Beneath the
price series I have also plotted the 63 Day ROC% indicator and also the ATR% Indicator.

Note that when $RWR was trading sideways there was an edge to buying if price was trading
towards the lower Keltner Band, or towards price support, or when the Oscillator became
oversold.

If you were analysing an individual REIT such as $AGNC, you would want to avoid placing
a buy order if your analysis of the broader REIT sector showed that it was trading sideways
and also trading at the top of a range.

These are just some simple ideas that you can test for yourselves if interested in shorter-term
or swing trading setups.

For example, note in the following chart that the market type for most of the period being
analysed was sideways normal or sideways quiet.

We see that during this market type it was profitable to sell at the upper Keltner bands or
when the oscillator was high. It was also profitable to buy at the lower Keltner bands or when
the oscillator was low.
In the next lesson you can download an Amibroker explorer which will make your
market/sector type analysis easier.

For example, the explorer tells you both the market type and whether or not the price is
trading towards the top or bottom of a price range.

Note that today (06/07/17) there are a few sectors which are both sideways and trading
towards the bottom of their range.
A profitable trade idea would be to place a buy stop order for XLK above today’s high.

Reasons for the trade include the sector being sideways normal and also trading at an obvious
level of prior price support and the lower Keltner Band.

If the entry order is filled then an initial profit target for the position would be placed at the
most recent 10 ten day high.

Stops would be placed beneath the most recent 5 day low or at least 1.1 * ATR below entry
price. Whichever is lower.

Approximate 2.3 R gain if trade is successful.

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