What is the Spearman Indicator?
Similar to a pendulum that keeps going back and forth, sometimes prices of stock keep fluctuating up and down in a particular range. The price fluctuation in the range is beneficial for traders to book the profits. But, how to identify a particular range? The Spearman indicator is used to find the range of price fluctuation in the range trading strategy.
What is Range Trading?
Range trading is used when there is no particular trend prevailing in the market. It is when market movements constantly occur between two price levels for a certain time. This can be used for all time frames from five-minute charts to daily and monthly charts.
According to this strategy, traders identify overbought and oversold territories which are also known as support and resistance areas respectively. The traders tend to buy at support and sell at resistance areas.
In trend trading, traders go with the prevailing trend. They go long in the uptrend and take a short position in the downtrend. In contrast, traders take both long and short positions based on the position of price within range in range trading.
To confirm that neither an uptrend nor a downtrend is prevailing in the market, the price must recover at least twice from the support area and move back at least twice from the resistance area. The next step is to identify the exact range. Then, the traders need to enter either a long or short position whichever is beneficial.
Role of a Spearman Indicator
The Spearman Indicator is derived from the British psychologist and mathematician Charles Spearman. Though, it was discussed by Dan Valcu in the Stock and Commodities Magazine.
Denoted by p (rho), it is popularly known as Spearman’s rank correlation or Spearman coefficient. It is used to determine how strong is the link between two datasets using a monotonic function.
A monotonic relationship is when:
- As the value of one variable increases, the value of another variable also increases
- As the value of one variable increases, the value of the other variable decreases
Although, the rate of increase or decrease is not necessarily constant.
The Spearman correlation ranges between +1 and -1. Here, +1 means to suggest a direct relationship between variables or perfect strength. - 1 indicates the inverse relationship of variables or negative strength between them. If the correlation value is zero, it suggests that both variables are not associated with each other.
Being used in technical analysis of the stock, the Spearman indicator is helpful to see how strong the prevailing trend is. It indicates the correlation between trends and price movements. The two datasets used for this purpose are actual prices and sequential series of prices. A monotonic function is assured by comparing the volatility in security prices with price trends.
Spearman’s ratio is calculated using above mentioned datasets and multiplied by 100. Therefore, the Spearman rank correlation values in this indicator range between +100 and -100. However, these extremes are very rare. Values above +80 indicate an uptrend whereas values below -80 indicate a downtrend.
How to trade using Spearman Indicator
Spearman indicator gives clear buy and sell signals. These are based on the action of indication at zero level. Traders should enter when the uptrend is signalled by a long-term spearman indicator that is more than zero. A short position should be entered when the long-term spearman indicator is less than zero and signal a downtrend.
Traders should exit the long position when the spearman indicator drops below zero and a short position when it rises above zero. It also aids in arriving at a stop-loss level.
To conclude, the Spearman indicator is important to find out the correlation between two variables. When it comes to stock trading, it is an oscillator that compares two variables i.e. price and trend. It is significant as it provides buy and sell signals as well as helps to determine a stop-loss level. For more accuracy, the Spearman Indicator should be used along with other technical indicators.
