Stocks & Commodities V. 9:11 (431-434): The Midpoint Oscillator by Tushar Chande, Ph.D.

The Midpoint Oscillator

by Tushar Chande, Ph.D.

would like to share one of my own indicators based on the same underlying concept used in the

popular stochastics (%K) and Williams' %R overbought/oversold indicators.

To review, the formula for the stochastics %K is:
C - L5
%K = 100

H 5 - L5

where
C = Today's close
L5 = Lowest low in the last five trading days
H5= Highest high in the last five trading days
Here, the value of the current close is compared with the lowest low in the last five trading days. Then the
difference between the highest high and lowest low of the last five trading days are determined. These
differences form a ratio that shows the position of the close in its trading range on a scale of O to 100.
This percentage value is then multiplied by 100 to calculate %K.
The formula for the %R is:
H -C
%R = 100 5

H 5 - L5

where
C = Today's close

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Stocks & Commodities V. 9:11 (431-434): The Midpoint Oscillator by Tushar Chande, Ph.D.

L5 = Lowest low in the last five trading days

H5 = Highest high in the last five trading days
In this equation, the close is compared with the highest high for the last five trading days. The
denominator is the same as in the formula for the stochastics %K, the highest high in the last five trading
days minus the lowest low in the last five trading days.
So with stochastics, the %K compares the current close to the lowest point of the market ' s excursion
over the chosen lookback period, while %R compares it to the highest point. As a result of their
definition, the values range from 0-100% or 100%-0.
A NEW, IMPROVED INDICATOR
Instead of using the extremes of the range of the market's prices over a given lookback period, I like to
use the midpoint to assess the overbought or oversold condition. In general terms, for a given lookback
period, a market is overbought if it is far above the midpoint and oversold if it is far below the midpoint.
Because I wanted an indicator with positive and negative values, I used half the range as the measure of
distance from the midpoint. Intuitively, I defined the indicator as follows:
%M = 100

C - ( midpoint of range)
Half the range

I use the mnemonic %M to indicate the use of a midpoint reference. The midpoint of the range is simply
(H+L)/2, and half the range is (HL) /2 for a given lookback period. Hence, after some algebra, we can
precisely define %M as the following indicator:
%M=100 (2C-Hn-Ln)/(Hn-Ln)
where n is the lookback period. A five-period lookback would read thus:
%M=100 (2C-H5-L5)/(H5-L5)
This indicator fluctuates between 100 and 100. For example, if C=L, then:
%M = 100 (2L5 - H5 - L5) / (H5 - L5)
= 100 (-(H5 - L5)) / (H5 - L5)
= -100
Interestingly, %M can also be related to %K and %R as
%M = %K %R
= 100 ((C - L)/ (H - L) - (H - C) / (H - L))
= 100 (2C - H - L) / (H - L)
where we have dropped the number of lookback periods for notational convenience. Thus, %M may be

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Stocks & Commodities V. 9:11 (431-434): The Midpoint Oscillator by Tushar Chande, Ph.D.

thought of as a combination of %K and %R, and users can enjoy both indicators for the price of one.

Once the market reaches a severely overbought or oversold level,

it typically remains there for several weeks.
Overbought and oversold limits may be set at +70 and -70, or determined from the standard deviation of
the actual data. For example, for the weekly S&P 500 close, the standard deviation for %M is 66. Other
limits, such as +50 and -50, may be used, based on one's comfort level and the desired frequency of
trades. Alternately, a moving average of the %M values may be used to provide an action signal.
This indicator could be useful to serious investors as well, simply by using a relatively long lookback
period.
FOR EXAMPLE
Figures 1 through 3 show different market periods using a lookback period of 26 weeks. I have used 67
as the overbought/ oversold limits and included a nine-week exponential moving average for reference.
Figure 1 covers the 1982 calendar year. We started the year in negative territory, and the market was
severely oversold (%M = -100) in March, June and late July, generating three buy signals in March, June
and August (%M > -67). For even the most conservative investor using %M > 0 as the action level, %M
issued a buy the week ended August 20, 1982, at the very start of that great bull market. Even though
%M dipped briefly below 67 in November, it quickly rose above this level, and its moving average stayed
comfortably above 67.
Figure 2 covers the memorable 1987 calendar year. The market was very strong during the first quarter,
and the first sell signal occurred in mid-April. The consolidation carried the moving average below 67,
reinforcing the sell signal in mid-May. The market surged one last time but fell back below the 67 sell
trigger the last week in August, just one week after the then all-time high. The sagging moving average
reconfirmed the sell signal two weeks later (early September), and the tumble was on. The next clear buy
signal was produced in early December, not far from the shell-shock lows.
Figure 3 illustrates the period from January 1990 to mid-June 1991, covering the turbulent period of
operations Desert Shield and Desert Storm. The market rebounded strongly from the severely oversold
condition in January 1990 and the first warning sell signal came in mid-June. The market kicked up
briefly but weakened four weeks later to issue a strong sell signal in mid-July, a full two weeks before the
invasion of Kuwait in early August. As the market jittered near its lows, the first strong buy signal (%M
> -67, moving average > -67) emerged in early November. A strong buy signal was given in January even
under the most conservative criteria of M > 0.

ecently, the market has been weakening. The first warning signal to sell came in early May, and the

moving average seems to have turned downward, even though it is still above 67. Upward progress is
possible, but the weeks at the top are numbered.
These figures show that once the market reaches a severely overbought or oversold level, it typically
remains there for several weeks. The first breakout above or below an action level is often followed by a

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Stocks & Commodities V. 9:11 (431-434): The Midpoint Oscillator by Tushar Chande, Ph.D.

FIGURE 1: One possible use for %M is to wait for an extreme reading of-100, which warns of a very
oversold, condition. Waiting for the indicator to turn up from 100 indicates that the short- to
intermediate-term trend has turned up.

FIGURE 2: Waiting for the %M to drop below 67 is another approach to consider for sell signals. During
early 1987, the %M stayed near +100, indicating the market was very strong. The first sell signal
occurred in April.

Stocks & Commodities V. 9:11 (431-434): The Midpoint Oscillator by Tushar Chande, Ph.D.

FIGURE 3: Once a market reaches very oversold or overbought condition, it may remain there for
several weeks. A nine-week exponentially smoothed moving average can be used as a crossover
indicator to better time the market. Waiting for the %M and the nine-week ESMA to move back above
-67 improves the buy signal.

Stocks & Commodities V. 9:11 (431-434): The Midpoint Oscillator by Tushar Chande, Ph.D.

reaction in the other direction. For example, the so-called "dead-cat bounce" is visible in the
August-September 1990. The dissipation of downward momentum is evident in the weaker second
reaction in late September 1990. By the same token, is the short, sharp reaction up from the initial move
below 67 in mid-June 1990 the "jumpy giraffe jerk" or the "seventh-inning stretch"? You be the judge.
The %M indicator has merit in that it uses the midpoint of the price range for measuring
overbought/oversold conditions, thus producing positive and negative values. It also happily combines
%K and %R and could be a useful short-term or long-term indicator. I think it may be useful in a variety
of ways.
Tushar Chande holds a doctorate in engineering from the University of Illinois and a master's degree in
business administration from the University of Pittshurgh.

REFERENCES
Drinka, Thomas P., Steven L. Kille and Eugene R. Mueller [1985] . "Profitability of selected technical
indicators," Technical Analysis of STOCKS & COMMODITIES, Volume 3: December.
Hartle, Thom [1991]. "Comparing indicators: Stochastics %K versus Williams' %R," STOCKS &
COMMODITIES, June.
___[1991] . "Stochastics", STOCKS & COMMODITIES, March. Keel, Cynthia, and Heidi Schmidt [1987].
"Using stochastics," Technical Analysis of STOCKS & COMMODITIES, Volume 5: August.
Kinder, Robert J., Jr. [1987]. "Enhanced Williams %R," Technical Analysis of STOCKS & COMMODITIES,
Volume 5: May.
Lane, George C. [1984]. "Lane's stochastics," Technical Analysis of Stocks & COMMODITIES, Volume 4:
May/June.
Schirding, Harry [1984]. "Stochastic oscillator," Technical Analysis of Stocks & COMMODITIES, Volume 4:
May/June.
Schwager, Jack, and Norman Strahm [1986]. "How useful are stochastics for trading?" Technical
Analysis of STOCKS & COMMODITIES ,Volume 4:July.

Figures

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