Demark, Thomas - The TD Range Expansion Index

Stocks & Commodities V15:8 (353-359): The TD Range Expansion Index (TD REI): by Thomas DeMark

NEW TECHNIQUES

The TD Range Expansion Index (TD REI)

from years of research suggest that price comparisons other than day to day generally produce better indicator performance. This could be due to daily news events and other short-term factors that tend to influence oscillator behavior, often creating distortions and therefore invalid conclusions; one day’s price movement does not necessarily establish a price trend. Ideal overbought and oversold conditions are often overlooked if you restrict the comparisons to daily closing prices, rather than other price levels such as daily highs or lows. Consequently, most of my techniques have the following characteristics:

Here, the author of The The New Science of Technical Analysis and the brand-new New Market Timing Techniques explains how to use the TD R EI and and the TD Price Oscillator Qualifier. Qua lifier.

1 Ignoring day-to-day closing price comparisons, relying instead on intraday highs and lows.

by Thomas DeMark hroughout my 26-year career in the investment business, I have studied and tested many widely followed market timing oscillators. Overall, I have questioned their construction, ambiguous interpretation and discretionary application. Consequently, I have developed my own series of indicators, and to simplify their application, I have assigned to them an objective interpretive process. In The New Science of Technical Analysis I presented the TD Range Expansion Index (TD R EI), and now I have improved upon it, as explained in my latest book, New Market Timing Techniques . Here, then, is a discussion of salient TD R EI components, as well as the trigger mechanism referred to as the TD Price Oscillator Qualifier (T DPOQ). The TDPOQ is critical to the proper application and execution of the TD REI as well as many other widely followed overbought/oversold oscillators.

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TO START My frustration with most conventional overbought/oversold oscillators stems from the steps typically used to calculate them. Most often, the method for calculation requires not just a comparison of two consecutive daily closing prices, but also a series of daily indicator values calculated by using exponential smoothing. Other than the fact that it h as become market convention to perform these mathematical exercises for most widely followed indicators, there seems to exist no other reason to make such daily comparisons or complicated calculations. I am hard-pressed to demonstrate better results by applying formulas that are exponentially derived as opposed to being arithmetically derived. In addition, there is little to be gained by just using closing price comparisons as opposed to other price relationships. In fact, the results I have produced

2 Comparing the price activity every other trading day instead of day to day reduces the impact of shortterm market factors that may temporarily influence price activity. 3 Applying simple arithmetic, as opposed to exponential formulas, to arrive at indicator values.

TD RANGE EXPANSION INDEX The TD REI, which will be fully detailed shortly, can be applied to market price activity in several different ways. Some applications are obvious and similar to those commonly used by many market analysts. Other approaches that were at one time proprietary and that I am now making available are applicable not only to my set of market timing oscillators, but also to other market timing indicators. However, I must caution you: Although the performance results that appear in this article may create the impression that all market turns can be identified by following TD R EI and TDPOQ, this is not the case. No market timing technique or indicator is infallible. Just about the time you become convinced that one is, and you are comfortable with its application and performance results, it will invariably fail. Traders must realize that no technique, indicator or system is infallible. Stop-loss disciplines and money management techniques are important determinants of trading success and should not be dismissed or minimized. The TD REI construction may initially appear complicated, but it is much simpler to calculate and follow than most other popular market timing oscillators. The TD R EI is a ratio, and the calculation is as follows: • Compar Comparee the curren currentt trading trading day’s day’s intra intraday day high high with the intraday high two trading days earlier. • If the the current current trading trading day’s high is is greater greater than than the the high two trading days earlier, then a positive value is recorded; otherwise, record a negative value or zero if equal. • Compare Compare the current current trading trading day’s intraday intraday low low with the intraday low two trading days earlier.

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• If the current trading day’s low is greater than the low two trading days earlier, then a positive value is produced; otherwise, record a negative value or zero if equal. • These two differences are summed whether both are negative or positive, or one is negative and the other is positive. • Each day’s net value is added over the entire period evaluated, and the summation of this daily series becomes the value for the numerator portion. • Next, calculate the absolute value of the price difference between the current trading day’s high to the high two trading days earlier, and the absolute value of the price difference between the current trading day’s low to the low two trading days earlier. • These daily values are added together over the designated period and the summation of these values becomes the denominator for the TD R EI. Then multiply the ratio by 100. The TD REI value will fluctuate positive or negative and the range of movement will vary from 100 to -100. The concept of absolute value is designed to measure price movement from one price level to another, and to ignore whether the price movement is in a positive or negative direction. Research studies indicate that approximately 76-82% of the time, markets operate within a trading range. The identification of overbought/oversold indicator zones is usually effective within this environment. Of the 18-24% of the time in which markets trend, typically, 12-16% of the time it is upside and 68% of the time it is downside. The disparity between these statistics is likely to be attributable to the fact that buying is a cumulative decisionmaking process, psychologically re-


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inforced as prices move higher. However, selling generally constitutes a one-time decision — if a trader does not like a currently held trading position, then usually he liquidates it entirely. Whereas in most trading range markets, oscillators work well, in a trending market, most oscillators suffer from a major deficiency, since they tend to move into overbought or oversold states prematurely. TD R EI has been designed to reduce the likelihood of this occurring. When c omparing the high and low every other trading day, at least one of the following conditions must exist as well: A The current trading day’s high must be greater than or equal to the low of five o r six days ago and the current trading day’s low must be less than or equal to the high of five or six trading days ago or B The high of two trading days ago must be greater than or equal to the close of seven or eight trading days ago and the low of two trading days ago must be less than or equal to the close of seven or eight trading days ago. For example, if the current day’s high was greater than the low of five days ago and the current day’s low was greater than the high of five days ago, then the market is clearly in a strong trend. Condition A would n ot be met. Then, if the high and low of two days ago were both higher than the close of seven days ago, then condition B would not be met. Failure of both of these conditions indicate strength. These qualifiers serve to delay or postpone the oscillator from prematurely recording overbought or oversold readings in trending market environments, thereby reducing the likelihood of selling prematurely into price blowoffs to the upside, or buying prematurely into price blowouts to the downside. The price action must demonstrate that the trend is decelerating before a trader may entertain thoughts of executing a trade. When both these conditions are absent on a particular trading day, the standard TD REI version assigns a value of zero to that day’s oscillator value, whereas the alternate TD REI version assigns a value of zero to both that trading day ’s oscillator as well as the previous trading day’s value. For purposes of illustration, this entire discussion is devoted to the standard TD R EI, since all oscillator readings reflect an adjustment caused by allocating zero to only the current trading day if the required price intersection fails to be present. Finally, the daily values are summed and averaged over a five–trading day period and the TD R EI is plotted beneath the price action of the underlying security to facilitate p rice and oscillator comparisons (see sidebar, “TD R EI”). Trading experience indicates the market is oversold when TD REI declines below -43 and is overbought when TD R EI advances above 43. My research suggests that most markets present buying opportunities when TD R EI is oversold and selling opportunities when it is overbought. In some instances, however, markets are justifiably oversold and in-

stead of buying, a trader would be prudent to either withdraw from the market or sell short into the decline. Conversely, there are times when markets are justifiably overbought, and the prudent action would be to either forgo a trade or g o long with the trend. The difficulty is to distinguish between the various levels or degrees of overbought and oversold. To facilitate this distinction, I introduced the concept of TD Duration Analysis.

In most trading range markets, oscillators work well. But in a trending market, most oscillators suffer from a major deficiency, since they tend to move into overbought or oversold states prematurely. TD REI has been designed to reduce the likelihood of this occurring. Most traditional market analysts apply the concept of divergence analysis to identify possible market reversal points. Price activity at potential price tops and bottoms is related to oscillator values at comparable points in time for confirmation. TD Duration Analysis ignores this comparison and instead concentrates solely on the amount of time an oscillator remains in the overbought or the oversold zone. Divergence analysis can be described as a reflection o f the situation produced by extreme and subsequent mild overbought or oversold readings; divergence analysis is the symptom of a condition and duration analysis is the cause.

TD PRICE OSCILLATOR QUALIFIER The prescription for fine-tuning low-risk buy or sell entry levels once a mild oversold or overbought TD R EI reading is recorded is the TD Price Oscillator Qualifier (T DPOQ). To identify whether a market is likely to advance or decline, the following prerequisites must be fulfilled: • For a low-risk buy entry, TD REI currently, or most recently, must have been in the oversold zone and not the overbought area. • In addition, TD Duration Analysis requires that the amount of time in the oversold zone be less than six trading days. Otherwise, any indication of an advance must be deferred until TD R EI moves into the neutral area and retreats once again into the oversold zone and records a modest oversold reading, thus remaining in the oversold area for less than six trading days. • Once that condition is met, the first trading day in which the market closes greater than the prior trading day’s close is identified, and the intraday price high recorded that trading day serves as a low-risk entry reference level.



• TDPOQ, one variation of TD Trap from the TD series of breakout patterns, requires both the open of the next trading day be less than or equa l to the previous uptrading day’s high and that day’s high be greater than the upclose day’s high (Figure 1). Although there are exceptions, these price patterns indicate market strength expressed by the upclose as well as a degree of skepticism the following trading day, since the open is less than the upclose day’s high . On the other hand, if the open of the trading day after the upclose day is greater than both the upclose day’s high and the prior day’s high, the short-term urgency to buy as expressed by the aggressive buying at the opening suggests the possibility of a short-term price high — not a buying opportunity. For a low-risk sell entry, the conditions are reversed: • TD REI currently, or most recently, must have been in the overbought zone and not the oversold area.

C B

A

FIGURE 1: TDPOQ BREAKOUT PATTERN. TDPOQ requires both the open of the next trading day (A) be less than or equal to the previous uptrading day’s high (B) and that day’s high be greater than the upclose day’s high (C).

• In addition, TD Duration Analysis requires that the amount of time in overbought zone be less than six trading days. Otherwise, any indication of a decline must be deferred until TD R EI moves into the neutral area and advances once again into the overbought zone and records a modest overbought reading, thus remaining in overbought for less than six trading days.

A B C

• Once that condition is met, the first trading day in which the market closes less than the prior trading day’s close is identified and serves as a low-risk entry reference level. • TDPOQ requires both the open of the next trading day be both greater than or equal to the do wnclose day’s low and that same trading day’s low be less than the downclose day’s low (Figure 2). Once again was the opening price of the trading day following the downclose day less than either the downclose day’s low or the prior day’s low. The short-term urgency to sell as expressed by the aggressive selling at the opening implies the possibility of a short-term low — again, not a selling opportunity.

EXAMPLES The US Treasury bond chart seen in Figure 3 demonstrates the application and the interpretation of TD R EI and TDPOQ. Alternating periods of overbought and oversold oscillator readings are displayed and identified on the chart by solid horizontal lines positioned at levels -43 and 43. The instances in which the oscillator remains overbought or oversold for more than six trading days can be classified as extreme are identified on the chart with a TD Duration count of 6. Those times in which the oscillator remains overbought or oversold

FIGURE 2: BREAKOUT PATTERN. TDPOQ requires both the open of the next trading day (A) be both greater than or equal to the downclose day’s low (B) and that same trading day’s low (C) be less than the downclose day’s low.

for less than six trading days records a mild reading. Traders should avoid anticipating trend changes when severe or extreme readings are recorded. By introducing a count variable that appears on the chart, traders are made aware of this condition; nevertheless, disqualified T DPOQ trades appear to work, whether an extreme or mild overbought or oversold reading exists. Although a trader can often take advantage of overbought or oversold opportunities that occur over a shorter time interval, there is a specified series of events that must unfold sequentially to define and refine low-risk entry levels. The asterisks on the chart coincide with those instances in which the following prerequisites are fulfilled: 1 Five or fewer trading days in the oversold or overbought zone have occurred.



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FIGURE 3: T-BONDS. The US Treasury bond chart seen here demonstrates the application and the interpretation of TD REI and TDPOQ. Alternating periods of overbought and oversold oscillator readings are displayed and identified on the chart by solid horizontal lines positioned at levels -43 and 43. The instances in which the oscillator remains overbo ught or oversold for more than six trading days can be classified as extre me are identified on the chart with a TD Duration cou nt of 6. Those times in which the oscillator remains over bought or oversold for less than six tradin g days records a mild reading.

FIGURE 4: IBM. Figure 4 illustrates a similar s eries of TD REI low-risk buy and sell indications. Asterisks and hyphens display more TD R EI opportunities that either fulfill T DPOQ (*) or fail to fulfill T DPOQ (-).

2 TD REI has currently, or most recently, recorded either: a mild oversold TD R EI reading (below -43) and subsequently an upclose for an upside move; or conversely, both a mild overbought TD R EI reading (above 43) and subsequently, a downclose for a downside move.

same day exceeded the reference price level low. presenting a low-risk selling opportunity. A few trading days later, TD R EI moved into an oversold state and the first subsequent upclose occurred shortly afterward. However, the opening price of the next trading day exceeded the previous trading day’s intraday high (reference price as well as the prior day’s high), thereby failing to fulfill TDPOQ and disqualifying a low-risk entry at that time. In fact, a short-term overbought condition appeared shortly after the opening, since the open was above the reference day’s high and price was under pressure all day. Additional asterisks and hyphens display more TD R EI opportunities that either fulfill TDPOQ (*) or fail to fulfill T DPOQ (-). If TD REI is either oversold or overbought for more than five trading days, no activity is presented; however, the failures (-) could have been displayed. Figure 4 is the daily chart of I BM and illustrates a similar series of TD REI low-risk buy and sell indications. In addition, various potential TD R EI low-risk opportunities failed to fulfill T DPOQ by not opening within the previous trading day’s price range and exceeding the high for an u pside move or the low for a downside move. The same series o f codes — asterisks and hyphens — serve to define the various opportunities.

3 A TD Trap breakout is either recorded by opening within the previous trading day’s range (the upclose day) and exceeding that trading day’s high upside for an upside move or for a downside move, a TD Trap breakout is recorded by opening within the previous trading day’s range (the downclose day) and typically exceeding that trading day’s low downside. Condition 1 conforms to TD Duration requirements and conditions 2 and 3 fulfill the specifications of T DPOQ. Those instances in which TD Duration of five or fewer trading days are fulfilled, but the opening price occurs above the reference day’s intraday high and the prior day’s high for an upside move or below the reference day’s intraday low and the prior day’s low for a downside move are marked on the accompanying charts with a hyphenated designation (-). Trading that day should fail to follow through in the direction of the opening breakout, since the short-term price move is too aggressive. Exceptions to the latter proposition do exist but will not be discussed within the boundaries of this article. As you can see in Figure 3, TD R EI was mildly overbought in December 1996. After making the price high, the following trading day’s closing price was less than the prior trading day’s close. The next trading day’s opening price was above the downclose day’s low (reference price) and the low that

CONCLUSION Other qualifiers can be introduced to perfect this process, such as expanding or contracting the oversold and overbought oscillator band, allowing more than one opportunity (additional up- or downcloses) to reset entry possibilities, applying the alternate TD R EI calculation when intersection fails to appear, and making three- or four-day TD R EI comparisons rather than two-day comparisons. As you can readily observe by reviewing these charts, TD



THE TD REI (THE TD RANGE EXPANSION INDEX) The TD Range Expansion Index (TD REI) is an oscillator that uses unique steps in the calculation. The basis of the oscillator is a comparison of every other trading day’s intraday highs and lows to remove any one day’s random impact. In addition, there is an additional set of comparisons to reduce the likelihood of the oscillator reaching an overbought or oversold state prematurely when the market is trending. There are seven steps to calculating the TD R EI, which are detailed below for an Excel spreadsheet (Figure 1). The TD REI calculations are shown as applied to daily data for I BM beginning with January 2, 1997. The first five columns are date, open, high, low and close. The first set of instructions will begin on row 11, due to the lookback periods employed in the calculation. The first step, column F, calculates the difference between today’s high and the high two days ago. Enter into cell F11 the following formula and copy down: =C11-C9 Column G calculates the difference between today’s low and the low two days ago. En ter into cell G11 the following formula and copy down: =D11-D9 Next, the test for price overlap or intersection is performed. This test checks for the current bar’s relationship to the trading bars five or six trading days ago. The current day’s high must be greater than or equal to the low five or six trading days earlier and the current day’s low must be less than or equal to the high five or six trading d ays ago. A true statement will be returned if these criteria are met. In

cell H11, enter the following formula and copy down: =AND(OR(C11>D6,C11=D6,C11>D5,C11=D5), (OR(D11E4,C9=E4,C9>E3,C9=E3), (OR(D9
SIDEBAR FIGURE 1: IBM AND TD REI. After the differences are calculated in columns F and G, columns H and I check for overlapping bars.


—Thom Hartle, Editor


REI and TDPOQ do not speak often, but when they do, it pays to listen. Not only does TD R EI introduce numerous potential trading opportunities, but many times, the rigorous requirements of T DPOQ will serve to prevent premature entry into a market as well as maintain a trader’s commitment to a prevailing market trend. The highlight of applying this disciplined approach is its ability to eliminate o r at least reduce the trader’s tendency to be subjective or discretionary when applying conventional market timing oscillators to market price behavior.

Tom DeMark is author of The New Science of Technical Analysis , as well as New Market Timing Techniques . TD Range Expansion Index (TD R EI ), T DPOQ , TD Duration Analysis, and TD Trap are registered trademarks.

REFERENCES DeMark, Thomas R. [1997]. New Market Timing Techniques , John Wiley & Sons. _____ [1994]. The New Science of Technical Analysis , John Wiley & Sons. †See Traders’ Glossary for definition


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Demark, Thomas - The TD Range Expansion Index

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