What Is the Disparity Index?
The disparity index is a technical indicator that measures the relative position of an asset's most recent closing price to a selected moving average and reports the value as a percentage.
A value greater than zero—a positive percentage—shows that the price is rising, suggesting that the asset is gaining upward momentum. Conversely, a value less than zero—a negative percentage can be interpreted as a sign that selling pressure is increasing, forcing the price to drop. A value of zero means that the asset’s current price is exactly consistent with its moving average.
Similar to the Rate of Change (ROC) indicator, another momentum indicator, important signals are generated when the disparity index indicator crosses over the zero line because it is an early signal of an imminent rapid change in the trend, and therefore the price. Extreme values in either direction may indicate that a price correction is about to occur.
- The disparity index is a momentum indicator that indicates the direction an asset is moving relative to a moving average.
- Large moves in either direction for the index may foreshadow that a price correction is ahead—i.e. whether the asset is overbought or oversold.
- Akin to Rate of Change and other indicators, the disparity index is best used with other tools.
Disparity Index Explained
As a formula, the equation for the disparity index would be expressed as:
Disparity Index=n-period moving average value×100(current market price−n-period moving average value)
The introduction of the disparity index—at least to European and American traders—is attributed to Steve Nison, who discussed it in his book Beyond Candlesticks: New Japanese Charting Techniques Revealed (John Wiley & Sons, 1994). "A widely used Japanese tool is the disparity index," he wrote.
Steve Nison said the disparity index is "similar to Western dual moving averages, but this technique allows for better market timing.”
How Traders Use the Disparity Index
Contrarian investors, in particular, like the disparity index. The extreme values of this indicator can be a very useful tool for them to foretell periods of exhaustion—that is, whether an asset is overbought or oversold, and thus be vulnerable to an abrupt change.
Once the price is excessively pushed in one direction, there are very few investors to take the other side of the transaction when the participants wish to close their position, ultimately leading to a price reversal. So the disparity index is a good indicator of when following the trend of a given asset might be a dangerous proposition.
A disparity index above zero suggests upward momentum, while less than zero may indicate a rise in selling pressure.
Just like other momentum indicators, the disparity index indicator is most suited when used along with other tools when a trader is trying to spot possible reversals or confirm a trend.