Understanding the Kairi Relative Index

[RichardCox 10]

Understanding the Kairi Relative Index

 

When deciding on which chart indicators to use, technical analysts will often come from one of two schools. There are those that use indicators employed by the majority, as this will give a sense of what most traders are likely to do next. But there are also traders that look to utilize indicator tools that are not as well known. The argument here is that less commonly used indicators can send signals that might not be visible to most market participants. Both approaches have their advantages. But it is always a good idea to have at least some idea of how to use the lesser known indicators so that you can understand the analysis of other traders and capitalize on opportunities when they emerge.

 

The Kairi Relative Index Defined

 

Most traders that base trades on price action and technical analysis will almost inevitably come across the Relative Strength Index (RSI), which was developed by market guru J. Welles Wilder. This commonly used charting tool is generally used to get a sense of when prices have become overbought or oversold. A lesser known tool that in some ways bears a resemblance to the RSI is the Kairi Relative Index (KRI), which originated in Japan but was developed by an unknown trader. The word “kairi” means “separation,” which is appropriate given the way it is used to identify the underlying relationships found in trending markets.

 

Considered both an oscillator and a leading indicator, the Index plots the deviation of the current price relative to its simple moving average (SMA). This deviation is then given as a percentage of that moving average. When these deviations show that trends are overextended, contrarian positions can be taken based on the potential for reversals. This means sell positions in an uptrend, or buy positions in a downtrend. This is the formula for the KRI calculations:

 

 

Here, SMA refers to the Simple Moving Average. N refers to the number of time intervals used in the SMA (default is usually 14 periods).

 

Plotted visually, the KRI looks like this:

 

 

Comparisons to RSI

 

The RSI and KRI are clearly individual indicators, with varied differences. But the best way to understand the inner workings of the KRI is to view it in comparison with the widely understood RSI. As momentum oscillators, these tools measure the rate of change in market prices. When prices rise, momentum is increasing. Once those gains start to falter and decline, that momentum drops. The values in both the RSI and KRI change as markets fluctuate but since the calculations in both tools vary, their readings will send different signals. In the chart below, we can compare the readings on both indicators relative to the same price action:

 

 

The comparisons here in the overall trajectory should be clear. But when we look at the KRI, it can be argued that the signals are more clear, given the slightly more extreme nature of the plotted fluctuations. In this way, the KRI can be described as more of a moving target indicator.

 

Oversold and Overbought Regions

 

But what we are really looking for in the chart above is evidence that prices have either become oversold or overbought. In the chart below, we can see overbought price action as the indicator reaches the top of its range. Oversold price action can be seen as the indicator reaches the bottom of its range.

 

 

Indicator Divergences

 

In previous articles, I have outlined some of the characteristics of divergences and hidden divergences. The KRI can be used to identify these market events, as well. When price action and the KRI show divergences, buy and sell signals can be signalled. If prices are making new lows and the KRI is NOT making new lows at the same time, a bullish divergence is in place and buy positions can be established. If prices are making new highs and the KRI is NOT making new highs at the same time, a bearish divergence is in place and sell positions can be established. The chart graphic below shows an example of a bullish divergence:

 

 

The next chart graphic shows an example of a bearish divergence:

 

 

Crossovers and the Centerline

 

The KRI will also send signals to buy and sell when prices cross above and below the zero line. When prices cross the zero line from above, a sell signal is given. When prices cross the zero line from below, a buy signal is given. Examples can be seen in the chart below:

 

 

Comparative Calculations

 

When looking at the KRI calculations (the deviation of prices from its SMA, shown as a percentage), you will be looking to sell the asset when the percentage is high and positive. When the percentage is high and negative, it is time to buy.

 

When we look at the calculations of the RSI, we see numbers that are based on closing periods and whether those periods close up or down. This is the formula for the RSI:

 

 

Here, RS is the average gain over the average loss, and is the reason the RSI is categorized as an oscillator. In non-mathematical terms, this formula essentially describes where prices have been and the likelihood prices will continue in the same direction. Both the RSI and KRI use a default 14-period setting for their SMAs. If you are looking for a response to markets that is faster, the indicators can be customized to use fewer periods. Slower signals tend to be more accurate but produce fewer signals. For this, you will need to set your periods higher than 14.

 

Center Lines

 

“The RSI and KRI are both categorized as center line oscillators, which means that the center line is of primary importance,” said Vlad Karpel, options strategist at TradeSpoon. “This is the area that determines whether you should exit or enter a trade, and whether your position should be short or long.” The center line can also help you to determine whether the dominant market condition is a trend or a range. In the RSI, traders will generally go short when the RSI rolls over from above 70 and go long when the indicator rolls up from below 30. Potential drawbacks are seen here if prices remain above 70 or below 30 for extended periods of time.

 

In contrast, the KRI attempts to signal market reversals in their early stages or to produce signals when prices diverge from indicator activity. In the RSI, the center line is 50. In the KRI, the center line is zero. On average, the KRI is equal to roughly 500 pips from the center line to the top of its range. It is also 500 pips from the center line to its range bottom. This is slightly less than the 600 average that is seen in the RSI.

 

Conclusion: The KRI and RSI Pose Subtle But Important Differences

 

For technical traders that are looking for a new spin on the commonly used indicators, the KRI is one option that should be considered. Many traders are already familiar with the inner workings of the RSI indicator, so it is not a significant step to make the leap and test out the KRI, as well. There are advantage and drawbacks in both cases but if you are looking for ways to gain a different perspective on what the majority of the market is doing at any given moment, the KRI presents a viable option for an alternative indicator choice. Trades can be based on a variety of signal types -- divergences, center line crossovers, or evidence that markets have strayed too far from their moving averages (overbought or oversold conditions). This variety of signals offers traders a large number of tools that can be used when looking to construct new trade ideas.