Technically Speaking Archives
Technical Indicators & Overlays
by CI Staff
The Mass Index was developed by Donald Dorsey and uses a high-low price range to identify potential trend reversals based on range expansions. It is based on the notion that there is a tendency for trend reversals when the price range (the difference between the high and low prices) widens. The Mass Index is a volatility indicator that identifies “range bulges” that may foreshadow a reversal in the current trend. Unlike many technical indicators, the Mass Index has no directional bias; instead it depends on the direction of the existing trend when the bulge occurs. Using this indicator in conjunction with others, such as moving averages or the MACD (moving average convergence/divergence), can help you forecast the direction of the next trend.
Calculating the Mass Index
The Mass Index is made up of four parts:
- Single exponential moving average ( : Nine-period EMA of the high-low price differential. This single EMA provides an average for the high-low range.
- Double EMA: Nine-period EMA of the nine-period EMA of the high-low price differential. The double EMA provides a second smoothing of the volatility measure.
- EMA ratio: Single EMA ÷ double EMA. By using a ratio of the two EMAs, we are normalizing the data series. The ratio shows when the single EMA is becoming large relative to the double EMA.
- Sum of the EMA ratio: 25-period sum of the EMA ratio. This acts like a moving average to further smooth the data series.
The Mass Index rises as the high-low range widens and falls as the high-low range narrows. We have provided a downloadable spreadsheet at ComputerizedInvesting.com that illustrates how the Mass Index is calculated.
Typically, the Mass Index fluctuates in the mid-20s, with readings near the high end of the historical range suggesting rising volatility and increasing chances for a trend reversal. In his own analysis, Dorsey looked for “reversal bulges” to signal a trend reversal. For him, these bulges occurred when the Mass Index moved above 27. However, this wasn’t the end of the signal. Instead, he then waited for the Mass Index to reverse and move below 26.5. Then, using other analytical techniques, he determined the direction of the next trend. However, generally speaking, a downward trend followed by a reversal bulge would suggest a bullish (upward) trend reversal. Likewise, an uptrend followed by a reversal bulge would suggest a bearish (downward) trend reversal.
However, the Mass Index extremes that mark a possible reversal bulge will vary from security to security, and most likely you’ll need to relax the requirements based on the historical range of the security you are analyzing. The lower the threshold for the reversal bulge, the more signals the Mass Index will generate. However, you also run the risk of generating more meaningless signals. Therefore, it is important to examine the Mass Index levels over time for an individual asset to determine the historical high and low levels. Then, any move that nears the high end of the historical range would suggest a volatility bulge that may foreshadow a trend reversal. Ideally, a downtrend followed by a reversal bulge would suggest a bullish reversal. In contrast, an uptrend followed by a reversal bulge would suggest a bearish trend reversal. However, it is a good idea to use other analytical techniques to help identify the direction of the reversal.
Figure 1 shows a daily chart of Chevron Corp. (CVX) from StockCharts.com covering the 18-month period ending November 15, 2013. This is an example where we lowered the threshold for a reversal bulge to generate more signals. The chart shows that the Mass Index for CVX rose above 26 on four occasions over this 18-month period. However, to generate more meaningful signals, we raised the threshold to 26.25, reducing the number of reversal bulges to two—in November 2012 and again in June 2013. On both occasions, CVX shares were in a downtrend when the Mass Index moved above 26.25, suggesting that a bullish reversal would follow. As the chart illustrates, this is exactly what happened.
The Mass Index is a volatility indicator that uses the high-low differential. A rising Mass Index indicates that the differential is increasing. This increase in volatility often means that a trend reversal is imminent. Readings near the high end of the historical range suggest a “volatility bulge,” which is the signal that the trend may be reversing.
While Dorsey set the bulge threshold at 27, it often takes extraordinary volatility to push the Mass Index that high. Analyzing the historical range of the Mass Index for a security may help you identify the level that generates meaningful signals.
Furthermore, the Mass Index does not have a directional bias; it depends on the existing trend. Using the Mass Index in conjunction with other indicators can reveal the direction of the trend reversal.