What is the Elder-Ray Index?
The Elder-Ray Index is a technical indicator developed by Dr. Alexander Elder that measures the amount of buying and selling pressure in a market. This indicator consists of three separate indicators known as "bull power" and "bear power", which are derived from a 13-period exponential moving average (EMA). The three indicator help traders determine the trend direction and isolate spots to enter and exit trades.
- The Elder-Ray Index is designed to be a trend following system, where all three indicators are used to confirm a trade.
- If the EMA is sloping upward, consider long positions if the bull power is rising and bear power is in negative territory and rising (getting weaker)
- If the EMA is sloping downward, consider short positions or selling if the bull power is above zero and falling (weakening) and the bear power is falling.
- Another option is to watch the EMA as well as the overall trend in the power indicators. A downward sloping EMA along with a lower swing high in the bull power could signal a short, while a rising EMA and higher swing lows in the bear power could signal a long position.
The Formula for the Elder-Ray Index is
Period High or Period Low = The high or low price for the time period being used, such as a daily chart or a 1-hour chart.
How to Calculate the Elder-Ray Index
- Calculate the 13-period EMA for the time period being used. For example, if using a daily chart, calculate the EMA based on the last 13 days.
- Find the period-high price and subtract the 13-period EMA from it to get the bull power value.
- Find the period-low price and subtract the 13-period EMA from it to get the bear power value.
- Repeat steps one through three each time a period ends.
What Does the Elder-Ray Index Tell You?
Technical traders will use the values of bull and bear power, along with divergence, to make trading decisions. Long positions are taken when the bear power has a value below zero but is increasing, and the bull power's latest peak is higher than it was previously (rising). A short position is taken when the bull power value is positive but falling, and the bear power's recent low is lower than it was previously (falling).
The slope of the EMA can also be used in both cases to help confirm the direction of the trend. Traders can watch for the bull and bear signals and then wait for the EMA to start moving in the anticipated direction before taking a trade, or sometimes the EMA will already be moving in a particular direction and then the bull/bear power indicators will provide a confirming trade signal.
Dr. Elder's method generally uses a 13-day exponential moving average (EMA) to gauge the market's consensus of value. This may be altered based on personal preference. Bull power measures the ability of buyers to drive prices above the consensus value, while bear power measures the ability of sellers to push prices below the consensus value.
Most charting platforms require three windows to be open on one chart when using the Elder-Ray approach.
- Window one includes a bar or candlestick chart with the 13-period exponential moving average.
- Window two shows the Elder-Ray Bull Power indicator.
- Window three shows the Elder-Ray Bear Power indicator.
The Difference Between the Elder Ray Index and the Average Directional Index (ADX)
The Average Direction Index (ADX) is derived from the Positive Direction Index (+DI) and Negative Direction Index (-DI) which measure bullish and bearish movement similar to the bull and bear power indicators. The main difference is that +DI and -DI are smoothed averages divided by the average true range (ATR). Therefore, while all these indicators are measuring upward and downward movement, the calculations are quite different and therefore they will look different and provide different trade signals on a chart.
The Limitations of Using the Elder Ray Index
The Elder-Ray Index is prone to whipsaws, as the bull and bear power indicators will often oscillate above and below zero.
Also, the Elder-Ray Index is a lagging indicator, as it is based on historical price data. Therefore, it may react slowly to price changes. For example, a sell signal may occur after the price has already dropped significantly. This can problematic if using the indicator for buy and sell signals. To help remedy this problem, set stop loss orders at the time of the trade to help control risk.
Ideally, don't use the Elder-Ray Index in isolation. Rather, combine it with other forms of analysis, such as price action trading, other indicators, or chart patterns.