- 1997: Volume 6, No. 3 Know Your Data... Know Your Indicators

During the last several years, the use of computerized trading systems and technical market indicators has exploded. Today, it is not uncommon to even hear fundamental analysts talking about a market being overbought or oversold-terms which were once reserved for the market technician. However, while the exposure and use of technical market indicators is welcome, traders are urged to have a complete understanding not only on the proper use of an indicator but also on its calculation and input data.

One common denominator in the calculation of technical market indicators, in their simplest form, is the comparison of the current market price with an historical price. This is true for some of the more widely known and used indicators such as stochastics, relative strength index (RSI) and momentum or rate of change. All of these indicators can be calculated on varying time frames from minutes all the way to years. Since the range of price movement will expand as the time under consideration increases, it is fair to say that an indicator could be more sensitive to any distortions in data as the time horizon is shortened. Since bond futures now trade almost continuously beginning with the evening session followed by the Project A session and then finally the day session, the calculation of various technical indicators especially the ones that use intra-day prices will incorporate the various trading sessions in their calculation. The evening and Project A sessions occupy a combined 13 hours and 30 minutes of trading while the day session lasts six hours and 40 minutes.

Interestingly, most of the daily price range occurs during the day session as does more than 90 percent of the trading volume. Most technicians recognize the relationship between volume and price. Simply stated, volume is considered necessary to validate price. Yet users of certain intra-day technical indicators need to be aware of the price data used in the indicators' calculation. For example, using a 60 minute stochastic indicator may contain hours where there was a very small trading range and hardly any trading volume. Why should that be weighed equally with a period during the day session where a large range and heavy volume may have traded? We would argue that during most times the evening and Project A sessions, trading should carry little or no weight toward an indicators' construction. Again, this is because during the evening and Project A sessions prices were not validated with trading volume.

Fortunately, the Bridge Profit Center terminal is equipped with the option of including evening and Project A session data in the price charts and the calculations for the technical indicators.

The simplest way to illustrate this key point is to view an intra-day chart, say a 60 minute chart, along with a nine period stochastics indicator. Figure 1 is made up of prices from all trading hours. Notice how the stochastics indicator has issued an oversold buy signal. Traders following this indicator would be establishing long positions. Figure 2, on the other hand, contains only day session prices. Notice the different message that the stochastics indicator is sending. Here the stochastics is positioned neutral and remains on a sell signal. Traders following this indicator would not yet be establishing long positions and may still be positioned with shorts.

Figure 1 All Trading Hours

Figure 2 Day Only Trading

Traders should continue to be cognizant of all the prices that trade for a particular market regardless of what time of the day the trade occurred. Often an overnight price level will continue to act as future support or resistance. But traders should refrain from using technical indicators blindly without consideration to their formula for construction and their input data. Furthermore, traders and analysts may wish to test their favorite intra-day technical indicators to determine if the signals they generate vary with the inclusion/exclusion of evening and Project A session price data.

Walter J. Burke is a Chartered Market Technician and senior technical analyst with MCM Money-Watch, part of MCM Inc., a real-time global market analysis firm headquartered in New York. For further information, contact mcm@kisnet.com.