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Technical Indicators: A (part 3)
Alpha
Alpha is a measurement of the residual risk that an investor takes as a result of investing in a fund rather than in a market index. It represents the difference between a mutual fund's actual performance and the performance that would be expected based on the level of risk taken by the fund's manager.
If a fund produced the expected return for the level of risk assumed, the fund is said to have an Alpha of zero. A positive Alpha indicates a return greater than expected for the risk taken. A negative Alpha indicates the manager has not adequately rewarded investors for the risks taken.
Alpha = [ (sum of y) - {b * (sum of x)} / n ]
where:
n = number of observations
b = Beta of the fund
x = rate of return for the benchmark index (often, but not always, the S&P 500)
y = rate of return for the fund
Alpha Jensen
Developed by Michael Jensen, Jensen Alpha quantifies the performance of a investment with respect to a benchmark.
The Jensen Alpha is equal to the Investment's average return in excess of the risk free rate minus the Beta multiplied by the benchmark's average return in excess of the risk free rate.
Positive Alphas indicate good performance while negative Alphas indicate weak performance. The period of an Alpha should be for long-term review, 3 years or longer.
Arms Index (TRIN)
The Arms Index is a market indicator that illustrates the relationship between the number of stocks that increase or decrease in price (advancing/declining issues) and the volume associated with stocks that increase or decrease in price (advancing/declining volume). To calculate it, divide the Advance/Decline Ratio by the Upside/Downside Ratio.
The Arms Index is primarily a short-term trading tool, showing whether volume is flowing into advancing or declining stocks. A reading below 1.0 indicates more volume in rising stocks and is positive. A reading above 1.0 reflects more volume in declining issues and is negative. The Arms Index is a contrary indicator that trends in the opposite direction of the market. It can be used for intraday trading by tracking its direction and for spotting signs of short term market extreme.
The Arms Index was developed by Richard Arms in 1967. Over the years the index has been referred to by a number of different names. When Barron's published the first article on the indicator in 1967 they called it the Short-term Trading Index. It has also been known as TRIN (an acronym for TRading INdex).
According to Arms, a 10 day average of the Arms Index above 1.20 is considered oversold, while a 10 day Arms value below .70 is overbought, although those numbers may shift depending on the overall trend of the market.
Aroon Indicator
The Aroon Indicator was developed by Tushar Chande. Its comprised of two plots one measuring the number of periods since the most recent x-period high (Aroon Up) and the other measuring the number of periods since the most recent x-period low (Aroon Down). The plotted value is on a "stochastic" like scale ranging from 0 to 100. So, for example, if in a time-period of 14 days a security makes a new 14-day high, the Aroon Up = 100. When the security makes a new 14-day low, the Aroon Down = 100. When the security has not made a new high for 14 days, the Aroon Up = 0 and when the security has not made a new low for 14 days, the Aroon Down = 0.
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When the Aroon Up line reaches 100 it is a sign of strength. If the Aroon Up persists between 70 and 100, a new uptrend is indicated. Likewise if the Aroon Down line falls to 100, potential weakness is indicated. If the Aroon Down remains persistently between 70 and 100, a new downtrend is indicated. A strong uptrend is indicated when the Aroon Up line persistently remains between 70 and 100 while the Aroon Down line persistently remains between 0 and 30. Likewise a strong downtrend is indicated when the Aroon Down line persistently remains between 70 and 100 while the Aroon Up line persistently remains between 0 and 30.
When the Aroon Down line rises above the Aroon Up line, potential weakness is indicated and expect prices to begin trending lower. When the Aroon Up line crosses the Aroon Down line, potential strength is indicated and prices should begin to trend higher.
When the Aroon Up and Aroon Down Lines move parallel with each other then consolidation is indicated. Expect further consolidation until a directional move is indicated either by an extreme level or a crossover.
Aroon is a Sanskrit word meaning "dawn's early light" or the change from night to day.
Aroon Oscillator
Developed by Tushar Chande, the Aroon Oscillator is based upon his Aroon Indicator. Much like the Aroon Indicator, the Aroon Oscillator measures the strength of a trend.
The Aroon Oscillator is constructed by subtracting Aroon Down from Aroon Up. Since Aroon Up and Aroon Down oscillate between 0 and +100, the Aroon Oscillator oscillates between -100 and +100 with zero as the center crossover line. The Aroon Oscillator signals an uptrend if it is moving towards its upper limit. It signals a downtrend when it is moving towards the lower limit. The closer the Aroon Oscillator value is to either extreme the stronger the trend.
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