What is Mass Index
Mass index is a form of technical analysis that examines the range between high and low stock prices over a period of time. Mass index, developed by Donald Dorsey in the early 1990s, suggests that a reversal of the current trend will likely take place when the range widens beyond a certain point and then contracts.
BREAKING DOWN Mass Index
By analyzing the narrowing and widening of trading ranges, mass index identifies potential reversals based on market patterns that aren’t often considered by technical analysts largely focused on singular price and volume movements. However, since the patterns do not provide insight into the direction of the reversals, technical analysts should combine the indicator’s readings with directional indicators like the AD Line that specialize in predicting those types of things.
To determine the mass index, first calculate the nine-day exponential moving average (EMA) of the range between the high and low prices for a period of time – typically 25 days. Then divide this figure by the nine-day exponential moving average of the moving average in the numerator. The equation looks like this:
1∑259 − Day EMA of a 9 − Day EMA of (High − Low)9 − Day EMA of (High − Low)
Dorsey hypothesized that, when the figure jumps above 27 – creating a “bulge” – and then drops below 26.5, the stock is ready to change course. An index of 27 represents a rather volatile stock, so some traders set a lower baseline when determining the presence of a price bulge.
While you can use a lot of other technical indicators, such as standard deviation, to measure volatility, the reversal bulge function of the of the mass index can offer you a unique perspective about the market condition. You can also use mass index to trade trend continuations.
The mass index indicator can be a great tool for short-term trading, if a trader takes the time to change the sensitivity or periods according to the historical volatility of the particular stock they are studying.
Hypothetical Illustration of Mass Index
To get a better idea of what mass index truly does, consider driving a car and the mass index calculator, which shows volatility of the stock, is your speedometer. The speedometer of the car will only show how fast or how slow you are going, so you will probably need to use a compass to figure out if you are driving towards the north or the south – the compass being another technical indicator for determining direction. In other words, if you don't know what direction you're going, it matters very little how fast you're going.