Constructing rate-of-change midpoints, lookbacks and divergence

The comparison and its equilibrium-midpoint

Rate-of-change is built by comparing the latest close with the close n periods earlier. The same comparison can be applied to price, volume, or another series such as a moving average.

Three explicit constructions are given. The first is a ratio of the two closes scaled by 100. The second is a raw difference of the two closes. The third is that difference expressed as a percentage of the earlier close.

On the ratio construction an unchanged market prints 100, a decline prints below 100, and an advance prints above 100. On the difference construction the equilibrium-midpoint is zero and the sign matches the n-period price change.

Choose lookback-n for the holding horizon

Lookback-n is a free parameter. It sets which earlier close is compared with today and should be matched to the intended holding horizon and the instrument's variability.

Short-horizon use is described as five to twelve periods, with ten the most common choice. Intermediate horizons of five to twenty-six weeks are described as twenty-five to thirty days. Year-plus horizons are described as roughly three-month intervals.

Confirm timely crosses with a slower reading

A dual-lookback construction uses a short n for timely signals and a longer n to reject signals the slower oscillator does not confirm. A short, noisy reading can also be smoothed with a moving average. Those choices are the dual-horizon-filter.

A longer lookback is used as a trend filter. In the illustrated 30-period case the oscillator stayed negative through a multi-month decline and crossed back above its midpoint only after that decline had ended.

Pair a midpoint cross with the prevailing trend

The stated guideline pairs a midpoint cross with the prevailing price trend rather than treating an opposing cross as an equivalent signal. A charted 10-period reading remaining above its midpoint is read as an uptrend condition.

Construct divergence when pace fails at a new extreme

Divergence is constructed when price records a new high or low while the oscillator fails to confirm. That failure is read as a slowing pace and as a warning that price may later follow the oscillator rather than extend the unconfirmed extreme.

An extreme oscillator print coincident with a price extreme is used as an overbought or oversold marker. One illustrated 10-period sequence combined a joint extreme low, a later price-oscillator divergence on a retest, then a shift toward more time above the midpoint.

Combine the oscillator with other tools

The construction is not presented as a complete standalone mechanical system. Misleading signals are expected, so the oscillator is to be combined with other technical tools.