If you own a dog and a friend of yours enters your home, the dog will likely bark and announce the visitor. When your friend leaves after a while, your dog will do nothing.
Indicators should behave like dogs. If a new price is announced it should be greeted, however, if an old price drops out of the formula, this should not affect indicator values too much.
Unfortunately there is a whole lot of indicators that behaves in a way a dog would never do: It greets price and then barks again, when it leaves. This reduces the usability of the indicator.
I want to show via this thread, how this problem can be easily solved by using triangular moving averages. The first candidate is the momentum indicator.
The chart below shows a solid green candle, and what does the Momentum indicator do? It shows a considerable drop, because it greets away the larger candle that can be found 14 bars back. This simply does not make sense. The solution is simple. In the formula for the momentum, the price 14 periods back is simply replaced with the triangular moving average, which can be expressed as
and the momentum indicator will no longer behave in this disorderly fashion. As you can see the Balanced Momentum reacts to price in a similar way as the Momentum does, but it does not greet price away.
Last edited by Fat Tails; December 13th, 2010 at 03:01 PM.
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Just a observation though it may not apply to this case. If you were using a range interval maybe these sharp moves would be seen in a smoother way by the indicator and provide a better result. What do you think ?
The problem of old bars being greeted away by an indicator is mostly known from the simple moving average. It is created by wide ranging bars that drop out of the formula for the arithmetic mean. If you use range bars instead of fixed period bars, it is obvious that the impact of bars dropping out at the back end of the indicator is reduced, as you do not have bars with a wide range.
Due to possitive correlation with range, the problem is also reduced on tick and volume charts.
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