Why bother looking for different indicators just to have more signal confirmations? Let's learn how to use the Elder Ray Index to solve that problem more efficiently.

Elder Ray Index is a technical analysis indicator that was created by Dr. Alexander Elder, a well-known psychologist and trader. The indicator was designed for measuring the buying and selling power that are competing in a financial market so that the group driving the market in a particular moment can be determined. It is a trend-following indicator that informs traders of when to open and close their trading positions

Elder Ray Index

The Elder Ray Index consists of three indicators that are plotted separately:

  • An n-period exponential moving average (EMA).
  • The bull power indicator.
  • The bear power indicator.

 

The EMA

This is usually plotted as a separate component of the index on the chart and it is employed for calculating the bull power and bear power components of the index. Normally, the EMA is a 13-period exponential moving average for the closing prices, but any period can be used. The most important thing is to ensure that the same period is used for both the bull power and bear power components.

 

The Bull Power Indicator

This displays the relationship between the high price for a specific day and the n-period EMA as it confirms whether the day's high is higher or lesser than the EMA and whether there is a difference between them. To calculate the bull power, simply subtract the EMA from the day's high as shown in the formula below:

Bull Power = Current High – 13-period EMA (close)

This indicator is plotted separately in the indicator box and it is seen as a histogram.

 

The Bear Power Indicator

This is the third indicator of the Elder Ray Index and its job is to show the relationship between the low price for a particular day and the n-period EMA. It confirms the position of the day's low relative to the EMA while at the same time measuring the distance between them. To calculate the bear power, just subtract the EMA from the low price of a specific trading day as seen in the formula below:

Bear Power = Current Low – 13-period EMA (close)

 

How to read the Elder Ray Index Indicator

The Elder Ray Index Indicator enables traders to have a clearer picture of what is going on in the market. But for traders to fully utilize this function, all three components need to be read simultaneously. For the EMA, the trader needs to consider the slope as it can be an indicator of the prevailing market trend. For the bull power and bear power indicators, since they are plotted as histograms, then their positions in relation to the zero line need to be considered to determine if they are rising or falling.

Another point to consider when it comes to the bull and bear power histograms is a divergence from the price. Divergence refers to a condition in which the histograms and the price swings are not making corresponding highs and lows. The divergence could either be bullish or bearish; bullish divergence is seen when the bear histogram points to a higher low while the price is having a lower low, while  bearish divergence occurs when the bull power histogram points to a lower high while the price is making a higher high.

Combining everything, here is the standard way to read the Elder Ray Index:

1. A buying opportunity may arise if:

  • The EMA slopes in an upward direction which shows that there is a possible uptrend.
  • There is a negative (below the zero line) bear power histogram that is steadily rising.
  • The bull power histogram is also rising i.e. becoming more bullish

Buy setup from elder ray index

The setup is seen as stronger if the bear power histogram shows a bullish divergence as it means the buyer has a better buy setup.

 

2. A selling opportunity may arise if:

  • The EMA is in a downward slope which means that there is a possible downtrend.
  • There is a positive (above the zero line) bull power histogram that is falling.
  • The bear power histogram is also falling i.e. becoming more bearish.

Sell opportunities from Elder Ray Index

If the bull power histogram shows a bearish divergence, then it is an indication that the sell setup is quite strong.

 

When following the trend, you also need to learn how to identify when the price has run out of momentum so you don't get trapped trading at the ond of a trend. To do so, you can explore How to Know When a Trend is Ending.