Dr. Alexander Elder named his first indicator Elder-Ray because it is designed to see through the market like an X-ray machine. Developed in 1989, the indicator can be applied to any security chart. Elder-Ray helps traders determine the strength of competing groups of bulls and bears by looking for data that may not be immediately analyzed.
Key Takeaways
- Alexander Elder created the Elder-Ray indicator, designed to see through the market like an X-ray machine.
- The indicator is plotted as two separate histograms at the bottom of a chart and computed as an exponential moving average minus the high and low of the day.
- The slope of the EMA gives insight into the recent trend: up or down.
What Is the Elder-Ray Indicator?
The Elder-Ray indicator or Elder-Ray index has two key components: bull power and bear power. It also has exponential moving averages (EMAs) essential to the calculation. Price is a consensus among investors of value for any given security at a particular point in time. The moving average is simply a consensus of value that is extended for a certain window of time.
Mathematically, bull power is derived by subtracting an exponential moving average, like a 13-day EMA, of closing prices from a high price of any given security. Bear power subtracts the EMA from the corresponding low price of that trading day. Both bull power and bear power values are plotted as histograms under the bar chart of a chosen security.
Bulls vs. Bears
Traders commonly follow the slope of a moving average. When the slope rises, the crowd is bullish. When it falls, the crowd is bearish. The usual 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. The low represents the lowest value to which the bears are capable of pushing the price.
By measuring the distance from the high price of the day to the EMA, bull power represents the capacity of bulls to push prices above the average price. Bull power rises when bulls are stronger and falls when they are weaker.
Bear power 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 control.
Important
Elder-Ray is best used with other forms of fundamental or technical analysis and not as a standalone tool.
Using the Indicator
Conditions to look for when using the Elder Ray in making buying/selling and shorting/covering decisions:
- The trend is up, as indicated by EMA.
- Bear power is negative but rising.
Two additional conditions fine-tune the buying decision:
- Bull power’s latest peak is higher than it was previously.
- Bear power is moving higher from a bullish divergence. This situation provides traders with the strongest buy signal.
The corresponding sell signal is realized when prices hit a new high, but bull power reaches a lower peak than that of its previous rally. For shorting, two conditions are necessary:
- The trend is down as indicated by EMA.
- Bull power is positive but falling.
Two additional conditions provide a stronger signal for shorting but they are not essential:
- Bear power’s latest bottom is deeper than any previous bottom.
- Bull power is declining from a bearish divergence. As in the case of buying, the strongest signals for shorting are rendered by bearish divergences between bull power and prices.
In deciding when to cover short positions, traders must interpret the time at which bear power indicates the weakness or strength of bears. A new low in price with a new low in bear power points to a continued downtrend; however, with bear power tracing a shallower bottom than prices, a bullish divergence is realized: cover shorts and prepare for the ensuing uptrend.
Who Is Alexander Elder?
Alexander Elder, M.D., is a professional trader whose books include The New Trading for a Living. Dr. Elder was trained as a psychiatrist and served on the faculty of Columbia University.
What Is Fundamental and Technical Analysis?
Fundamental and technical analysis aims to predict future price movements and identify profitable opportunities. Fundamental analysis examines an asset’s intrinsic value by looking at economic and financial factors, while technical analysis focuses solely on price action and chart patterns.
How Do Investors Use Chart Patterns?
Price data can create a chart formation or pattern that a technical trader recognizes from a past analysis. Traders and investors can anticipate what the price may do next based on how that pattern played out when it previously appeared.
The Bottom Line
Divergences between bull or bear power and prices indicate the best trading opportunities using the Elder-Ray indicator. Equally important is the slope of the EMA, as the direction indicates the general trend.