Volume Oscillators: Klinger Oscillator, Money Flow Index

Klinger Oscillator

The Klinger Oscillator (KO) was developed by Stephen J. Klinger. The goal in developing this oscillator was to formulate a volume-based indicator that would be useful in both short- and long-term analysis. Klinger wanted an indicator sensitive enough to signal short-term turning points and also able to reflect longer-term trends in money flows into and out of a security.

Formulation

The Klinger Oscillator is based on the premise that the daily difference between accumulation and distribution can be qualified to create a volume force measurement behind price movement. When the daily high, low, and close are added together, a trend can be defined. Accumulation occurs when the current days sum is greater than the prior days. Distribution occurs when the current day's sum is less than the prior days. In the rare occurrence that the sums are identical, the existing trend remains in effect. The steps are as follows:

• Find the average price of the day by summing the high, low, and close and then dividing by three.
• If today’s average price is greater than the previous day's average price, assign a plus sign to today's volume.
• If today's average price is less than the previous day's average price, assign a minus sign to today's volume.
• Calculate a 34-period exponential moving average of the signed volume from steps 2 and 3.
• Calculate a 55-period exponential moving average of the signed volume from steps 2 and 3.
• Subtract the 55-period exponential moving average from the 34- period exponential moving average and plot the difference.
• Calculate and plot a 13-period exponential moving average of the daily differences from step 6.

According to Klinger, volume combined with intraday changes in price reveals buying and selling pressure. Volume Force is the difference

 Chart 10.55 Klinger Oscillator, Nasdaq 100 Trust ETF

between the number of shares being accumulated or distributed each trading day. Volume Force should confirm uptrends by rising along with price until the trend matures. At that point the Volume Force will contract, alerting the trader to a potential change in trend. The Klinger Oscillator is also meant to show positive divergences at bottoms as it begins to rise, which reveals accumulation before the trend actually changes.

The Klinger Oscillator is a centered oscillator, which means that buy and sell signals are generated when the oscillator crosses above or below a midpoint or zero line. It is not advised to follow signals against the trend in every case. For example, crosses above the zero line in a downtrend should not be blindly treated as buys, and crosses below the zero line in an uptrend should not be blindly treaded as sells. Chart 10.55 shows a basic plot of the Klinger Oscillator for the Nasdaq 100 Trust ETF (QQQQ).

Trend Confirmation

The Klinger Oscillator displays a different range during a downtrend as compared to an uptrend, demonstrating the characteristic of range shift. In the example of the continuous contract of the U.S. Dollar Index in

Chart 10.56 Klinger Oscillator, Downtrend, U.S. Dollar Index Continuous Contract

Chart 10.56, notice how the KO makes lower lows as price trends lower. Also note the range of the KO and how it peaks at points at or just above the zero line, which shows persistent selling pressure.

Next is a look at the daily chart of the S&P SPDR Select Retail ETF (XRT) (see Chart 10.57) as an example of the behavior of the KO in an uptrend. Notice how the oscillator stays in a range mostly above the zero line, making higher lows along with price while the oscillator also forms peaks well above the zero line, which signifies continued buying pressure.

Divergences

One of the strengths of the Klinger Oscillator is its ability to show divergences as trends mature. The KO shows evidence of weakening buying pressure in an uptrend by making lower highs as the trend continues. The KO also shows latent buying pressure as downtrends mature. In each case, the KO gives an early warning that the current trend is weakening and that a change in direction may be imminent. The S&P SPDR Select Retail ETF (XRT) in Chart 10.58 shows how the Klinger Oscillator revealed a pronounced negative divergence with price before prices reversed in early May 2010.

Chart 10.57 Klinger Oscillator during Uptrend, S&P SPDR Select Retail ETF

Chart 10.58 Klinger Oscillator, Negative Divergence, S&P SPDR Select Retail ETF

Chart 10.59 Klinger Oscillator, Positive Divergence, Market Vectors Gold Miners ETF

The KO is also a valuable tool to spot divergences at bottoms, alerting traders that buyers are beginning to enter the market. Notice in the example of the Market Vectors Gold Miners ETF (GDX) in Chart 10.59 how the KO detected the appearance of buyers as price made its final low in October 2008.

Cumulative Klinger Oscillator

Klinger also recommends a cumulative version of his KO. The idea is to accumulate the daily values by adding each day's value to a running total and to plot the result as a cumulative trending indicator. He also recommends a 13-day exponential moving average of the indicator, which is useful as a trigger line to enter and exit trades. The cumulative configuration gives the oscillator a completely different look.

Chart 10.60 is another snapshot of the Nasdaq 100 Trust ETF (QQQQ) shown earlier in the chapter, only this time with the Cumulative KO and trigger line. Note how stable the KO appears in showing its trends, but there is a significant lag factor. The Cumulative KO is good for showing long-term divergences, but its zero-line crosses come much too late to be used for short-term trading signals.

Chart 10.60 Cumulative Klinger Oscillator, 13-Day Exponential Moving Average, Long-Term Negative Divergence, Nasdaq 100 Trust ETF

Klinger Oscillator with Other Indicators

Since the Klinger Oscillator is a short- to intermediate-term oscillator, it is well paired with a short- to intermediate-term price momentum indicator. In this example, the KO will be paired with the MACD line. This shows which direction price and volume are moving, so it acts as a guide as to whether to either buy crosses up through the zero line or sell crosses down through the zero line.

In the example of the Industrial Select SPDR ETF (XLI) in Chart 10.61, the MACD line is making higher highs and higher lows, trending above its zero line in an uptrend. This suggests that crosses up through the zero line in the KO should be treated as buys. Chart 10.61 shows the buy points in the XLI uptrend from August 2009 to April 2010. Note how once XLI topped in April 2010, the next cross up signal in the KO and MACD came well after the correction.

Trade Setup

One of the Klinger Oscillator’s greatest strengths is in its ability to show divergences against the trend. This trade example demonstrates that feature along with its ability to act as a trade trigger by crossing its midpoint line or zero line.

Chart 10.61 Klinger with MACD Indicator, Buy Points, Industrial Select SPDR ETF

Note in Chart 10.62 how the price of Freeport McMoRan (FCX) pushed higher from January through early April 2010. During that time frame, buying pressure was on the decline, as depicted by the negative divergence in the KO. Note how the KO made lower highs as price made higher highs. A support line was drawn that connected the lows from January through March. A close below this support line along with the KO crossing below zero would be the trigger for a short trade.

Trade Entry

Chart 10.63 is a closeup of the same February-June time frame from the Freeport McMoRan example above. It shows that a trade could have been entered on April 16, 2010, as price closed below the support line, since KO had broken below zero 4 days earlier, on April 12. Remember, it is always wise to wait for price to confirm an oscillator signal of a change in direction by breaking either a support or a resistance line. An initial protective stop should have been placed above the April 6 high of 88.30.

 Chart 10.62 Cumulative Klinger Oscillator, Negative Divergence Trade Setup, Freeport McMoRan

Chart 10.63 Cumulative Klinger Oscillator, Negative Divergence Trade Entry, Freeport McMoRan

Trader Tips

The Klinger Oscillator, a centered oscillator designed to provide short-, intermediate-, and long-term analysis in one indicator, is best used for the following:

• Confirming the price trend
• Showing divergences against the price trend on new highs or lows
• Generating buy and sell signals with zero-line crossovers
• Functioning in a cumulative form for long-term looks at the market

A drawback of the Klinger Oscillator is that frequent short-term crossovers of the zero line can provide whipsaw trading signals.

Money Flow Index

The Money Flow Index (MFI) is a volume oscillator combining price momentum with volume; it is similar in calculation to the price-based Relative Strength Index (RSI). The incorporation of volume in MFI calculations, however, makes it a good measure of the strength of money flowing into and out of a security.

MFI compares positive money flow to negative money flow to create an oscillator that can be plotted with price. While most of the other volume oscillators presented have been zero-based, MFI is a banded oscillator, which means that it is plotted on a scale with clear overbought and oversold areas. The MFI is measured on a scale from 0 to 100 and is most commonly calculated using a 14-day period.

Formulation

The formula for computing MFI is a multistep process:

• Typical price = (day high 4 day low 4- day close) / 3 Raw money flow = (typical price) X (volume)
• Positive money flow = sum of raw money flow for the specified number of periods where typical price increased
• Negative money flow = sum of raw money flow for the specified number of periods where typical price decreased

Chart 10.64 Money Flow Index, Nasdaq 100 Trust ETF

Money ratio = positive money flow / negative money flow

The Money Flow Index is one of the most widely used volume-based indicators. Its computation over a 14-day period means that the price com-ponent has 14 data points to consider, making it a very robust indicator.

MFI is a great tool for identifying trends, overbought and oversold conditions, and divergences. All charts shown below use a 14-period Money Flow Index. Chart 10.64 shows a basic plot of the Money Flow Index for the Nasdaq 100 Trust ETF (QQQQ).

Trend Confirmation

As is common with many oscillators, the Money Flow Index shows different ranges in uptrends in comparison to downtrends. In uptrends, generally the MFI tends to make highs between 70 and 80 and lows between 35 and 45. The range shifts in downtrends, with highs between 60 and 70 and lows between 20 and 30. Chart 10.65 shows the MFI in an uptrend for the S&P 500 SPDR ETF (SPY). Note how the MFI tends to top at

 Chart 10.65 Money Flow Index during Uptrend, S&P 500 SPDR ETF

around 80 and bottom at around 40. The different range characteristics of the MFI in a downtrend are illustrated in Chart 10.66 of the same ETF, SPY. Note how during 2008 the MFI topped in the 60 to 70 range and regularly hit the 20 area at oscillator lows.

Detecting Overbought and Oversold Conditions

The MFI is widely used for evaluating overbought and oversold conditions in a stock, index, or commodity as long as price and volume data can be provided. The security being analyzed is considered overbought when the MFI reaches levels of 80 or above, suggesting that a price correction is due. Conversely, when the MFI falls to levels of 20 or below, the security is considered oversold and due for a bounce higher in price. With zero-based oscillators, buy and sell signals are generated by crosses of the zero line, but with a banded oscillator, buy signals are generated when the oscillator crosses up from oversold territory (in this case, below 20), and sell signals are generated when the oscillator crosses down from overbought territory (in this case, 80). Chart 10.67 shows the overbought and oversold default zones for the MFI for Cisco Systems (CSCO).

Chart 10.66 Money Flow Index during Downtrend, S&P 500 SPDR ETF

Chart 10.67 Money Flow Index, Overbought and Oversold Zones, Cisco System

Chart 10.68 Money Flow Index, Positive Divergences, KLA-Tencor

Divergences

The MFI is a great indicator for showing trend divergences. Positive divergences occur when price makes a new low while the MFI makes a higher low. The chart of KLA-Tencor (see Chart 10.68) shows two positive divergences on the same chart. Each divergence resulted in a strong rally. The second divergence occurred right at the March 2009 low.

The Money Flow Index also shows when a move higher may be near its end, alerting traders to take action if they so choose. Negative divergences occur when price makes a higher high but the MFI makes a lower high. Chart 10.69 shows a pair of negative divergences for the iShares Dow Jones U.S. Real Estate ETF (IYR), each followed by a sharp sell-off.

Money Flow Index with Other Indicators

Since the Money Flow Index is a banded oscillator, it is best paired with a cumulative trending indicator. In this example, MFI is paired with the Volume Price Trend indicator to identify the predominant trend. When Volume Price Trend is in an uptrend (i.e., with higher highs and higher lows), only buys will be considered. When Volume Price Trend is in a downtrend (i.e., with lower highs and lower lows), only short sells will be considered.

Chart 10.69 Money Flow Index, Negative Divergences, iShares Dow Jones U.S. Real Estate ETF

A setup for a buy trade occurs when the Volume Price Trend is in an uptrend and the MFI pulls back below 30 (i.e., it is oversold). Chart 10.70 shows buys in the 2009 uptrend in the S&P SPDR Select Retail ETF (XRT). In this case, the bottom (oversold) boundary on the chart example has been increased from 20 to 30, as it has been our experience that the MFI tends to make higher bottoms in an uptrend. Some good buying opportunities on pullbacks are missed by leaving the bottom (oversold) boundary at 20 in an uptrending market. The buy would then be executed when the MFI crosses back above 30, or out of oversold territory. This allows traders to effectively buy the dips as prices pull back in an uptrend. The sell setup would be just the opposite of the buy, using crosses down from overbought territory in a downtrend.

Trade Setup

The MFI can be used to time trade entry either by using its overbought/oversold readings or by looking at divergences confirmed by price action. In the following example, we will look at the latter situation. The example

Chart 10.70 Money Flow Index Combined with Volume Price Trend, Buy Signals in Uptrend, S&P SPDR Select Retail ETF

of continuous gold in Chart 10.71 shows how gold began an uptrend off its October 24, 2008, low. Price rallied up to a February 2009 high, after which a corrective pullback began. As the pullback developed, volume was not confirming the move lower; it decreased as price continued to fall. As price made its way down to its April 2009 low, volume decreased and the MFI made a higher low, forming a positive divergence. A downsloping resistance line was drawn that connected the highs from February to April. A close above that line would be a signal to execute a long trade and jump aboard the trend.

Trade Entry

The orderly pullback into the April 2009 low in the gold example, highlighted in Chart 10.72, showed that buyers were still in control and that the uptrend would resume once profit taking had run its course. Price closed above the downsloping resistance line on May 6, 2009. An initial protective stop should have been placed below the April 17 low of 865.60. In Chart 10.72, note how volume increased as price moved higher off its April low. This was yet another piece of evidence that buyers were in control of the gold market at that time.

Chart 10.71 Money Flow Index, Trade Setup with Positive Divergence, Gold Continuous Daily

Chart 10.72 Money Flow Index, Trade Entry, Gold Continuous Daily

Trader Tips

The Money Flow Index is one of the most widely used of the volume-based oscillators. Its robust price component complements its volume component to provide a greater depth of analysis than most price/volume oscillators. The Money Flow Index is used for the following:

• Confirming buying or selling pressure in a trend
• Showing trend divergences leading to potential reversals
• Indicating overbought and oversold market conditions
• Giving reliable buy and sell signals in the direction of the larger- degree trend

A drawback of the Money Flow Index is that it takes time to learn its characteristics in uptrends versus downtrends. The overbought/oversold levels often change, depending on the market trend. Traders should make sure to learn the tendencies of the MFI to top or bottom at certain levels, depending on the issue, market, and trend.