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Home  >  Technical analysis  >  Forex oscillator Elder rays

Forex oscillator Elder rays

Elder-rays is one of the most important technical indicators in forex market. Devised by Dr. Alexander Elder, is based on the concepts of bull power and bear power, the relative strength of bulls and bears in the market. Bull power measures the ability of market bulls to push prices above the average consensus of value, which is the actual price at which a particular stock happens to be trading for a given point in time. Bear power is the bears' ability to drive prices lower than current prices, or the current average consensus of value.

The Elder-rays combine the properties of trend following indicators and oscillators. They use 13-EMA (13 is the best period) as a tracing indicator. The oscillators reflect the power of bulls and bears. To plot the Elder-rays three charts should be used: on one side, the price chart and EMA will be plotted, on two other sides bulls power oscillator (Bulls Power) and bears power oscillator (Bears Power) will be plotted.

In interpreting the moving average, we are most concerned with its slope. When the slope rises, the crowd is becoming more bullish. When it falls, the crowd is more bearish. Clearly, the best course of action is to trade in the direction of the EMA. The high of the consensus of value occurs when bulls cannot lift prices any higher, thereby reaching their maximum power. And the low represents the lowest value to which the bears are capable of pushing the price, thereby reaching their maximum power. So the low shown on the daily bar is the maximum power of bears for the day; on the weekly bar is their maximum power during the week, and so forth.

By measuring the distance from the bar's high to the EMA, bull power represents the capacity of bulls to push prices above the average consensus of value (price). Bull power rises when bulls are stronger and falls when they are weaker, even becoming negative when they are utterly weak. Bear power, by contrast, is the capacity of bears to push prices below the moving average. The distance between the low and the EMA, which widens when the bears are weaker and narrows when they are stronger, gives this figure. Bear Power is typically negative, so if it turns positive, the bulls have taken complete control.

Elder-rays are used both individually and together with other methods. If using them individually, one should take into account that the EMA slope determines the trend movement, and position should be opened in its direction. Bulls and bears power oscillators are applied for defining the moment of positions opening/closing. The following positions should be opened:

Signals to buy (in brief):
there is an increasing trend (determined with the EMA movement);
the Bears Power oscillator is negative, but increasing at the same time;
the last peak of the Bulls Power oscillator is higher than the previous one;
the Bears Power oscillator increases after the Bulls divergence.
At the positive values of the Bears Power oscillator, it is better to keep back.

There are two absolutely essential conditions that need to be in place for traders to consider buying: 1) the weekly trend should be up, and 2) bear power, as represented on Elder-Ray, should be negative but rising. The second condition - negative bear power - is worth exploring. The opposite condition, in which bear power is positive, occurs in a runaway uptrend, a dangerous market environment for trading despite the apparent strength of the trend. The problem with buying in a runaway uptrend is that you are betting on the greater fool theory, which states that your profit will be realized only by eventually selling to somebody willing to pay an even higher price.

When bear power is negative but rising, bears are showing a bit of strength but are beginning to slip once again. By placing a buy order above the high of the last two days, your stop order will be filled only if the rally continues. Once you have gone long, you can protect your position with a stop below the latest minor low.

Bullish divergences between bear power and price (average consensus of value) represent the strongest buy signals. If prices fall to a new low but bear power shows a higher bottom, prices are falling and bears become weaker. When bear power moves up from this second bottom, you can comfortably buy a larger number of shares than you typically would in your usual position. (See Getting Confirmation With The Momentum Strategy and Momentum Trading With Discipline.)

You can also use Elder-Ray to determine the best time to sell your position. By tracking the pattern of peaks and valleys in bull power, you can ascertain the power of bulls. By stacking the peaks in actual price against the peaks in bull power, you can determine the strength of the uptrend - if every new peak in price comes along with a new peak in bull power, the uptrend is safe. When prices reach a new high but bull power reaches a lower peak than that of its previous rally, the bulls are losing their power and a sell signal is issued.

Signals to sell (in brief):
there is a decreasing trend (determined with the EMA movement);
the Bulls Power oscillator is positive, but decreases gradually;
the last trough of the Bulls Power oscillator is lower than the previous one;
the Bulls Power oscillator decreases leaving the Bears' divergence.

Do not open short positions when the Bulls Power oscillator is negative. Divergence between the Bulls and Bears Power and prices is the best time for trading.

If bull power is already negative, selling short is inappropriate because bears have control over the market bulls. If you short sell in this condition, you are effectively betting that bears have sufficient strength to push bulls even farther under water. Furthermore, as in the case discussed above, wherein the trader holds a long position during positive bear power, you are betting on the greater fool theory.

When bull power is positive but falling, the bulls have managed to grasp a bit of strength but are beginning to sink once again. If you place a short order below the low of the last two days, you receive an order execution only if the decline continues. You can then place a protective stop above the latest minor high.

In summary

Elder-ray indicatoris the most popular method of estimating power struggle between the bulls and the bears. It was developed and described by technician Alexander Elder. Elder based the indicator on the following premises:
The moving average is the agreed-upon price between the sellers and buyers during a certain period of time;
The maximum price reflects the maximum power of the buyers during the day;
The minimum price reflects the maximum power of sellers during the day.

On the basis of these premises, Elder defines the bull power as the difference between the maximum price and the 13-day exponential moving average (H-Ema). The bear power is the difference between the minimum price and the 13-day exponential moving average (L-Ema).

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