What is the disparity index?
The disparity index is a technical indicator that measures the relative position of an asset’s most recent closing price to a selected moving average and reports the value as a percentage.
A value greater than zero (a positive percentage) shows that the price is rising, which suggests that the asset is gaining momentum to the upside. Conversely, a value less than zero (a negative percentage) can be interpreted as a sign that the selling pressure is increasing, forcing the price to drop. A value of zero means that the current price of the asset is exactly consistent with its moving average.
- The disparity index is a momentum indicator used by technical analysts that indicates the direction an asset is moving relative to a moving average.
- Large movements in either direction of the index can herald that a price correction is coming, that is, if the asset is overbought or oversold.
- Like the Rate of Change (ROC) and other similar indicators, the disparity index is best used in conjunction with other tools.
Explanation of the disparity index
As a formula, the equation for the disparity index would be expressed as:
Disparity index = North-PMAV × 1(Current market price – North-PMAV)where:North-PMAV=North-Moving average value of the period
The introduction of the disparity index, at least for European and American traders, is credited to Steve Nison, who analyzed it in his book. Beyond Japanese Candlesticks: New Japanese Charting Techniques Revealed (John Wiley & Sons, 1994). “A widely used Japanese tool is the disparity index,” he wrote.
Similar to the Rate of Change (ROC) indicator (another momentum indicator), the disparity index generates important signals when it crosses the zero line because it is an early sign of an imminent rapid change in the trend and therefore the price. Extreme values in either direction may indicate that a price correction is about to occur.
Steve Nison said the disparity index is “similar to Western dual moving averages, but this technique allows for better market timing.”
How Traders Use the Disparity Index
Dissenting investors, in particular, like the disparity index. The extreme values of this indicator can be a very useful tool to predict periods of depletion, that is, if an asset is overbought or oversold and therefore vulnerable to a sudden change.
Once the price is pushed excessively in one direction, there are very few investors who take the other side of the transaction when participants want to close their position, ultimately leading to a price reversal. Therefore, the disparity index is a good indicator of when following the trend of a given asset could be a dangerous proposition.
A disparity index above zero suggests bullish momentum, while less than zero may indicate increased selling pressure.
Like other momentum indicators, the Disparity Index Indicator is best suited when used in conjunction with other tools when a trader is trying to spot potential reversals or confirm a trend.