The disparity index is a technical momentum indicator that compares market price to a time-defined moving average of market prices. Traders and analysts that use the disparity index to look for signals of trend strength and the possibility of coming exhaustion. Others use it to spot overbought or oversold positions for a given security; they are overbought when the index returns a value greater than or equal to the upper bound level, and they are oversold when the value is lower than the lower bound level.

The disparity index relies on the relationship between a current trading price and its most recent closing price. Differences are expressed as a percentage, helping to avoid misinterpretation based on strange trading volumes or ranges. As with any momentum indicator, the disparity index is best used along with other tools when trying to confirm trendiness or possible reversals.

A security's price may rise or fall rapidly within short periods of time. The aim of the disparity index is to measure just what is considered too sharp of a rise or fall, providing clarity in a situation that might otherwise be seen as random. The disparity index assumes that prices are reactive to overzealous periods of buying or selling, even within a trend. Traders use the disparity index to look for a continuation pattern in the short term or complete trend reversals in the long term.

Countertraders and contrarians make heavy use of momentum indicators such as the disparity index. However, despite being a valuable short-term tool, the disparity index is not meant to be a stand-alone trading instrument.

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  2. What is the disparity index formula and how is it calculated?

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  3. How do I use the disparity index in forex trading?

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