Understanding the Fisher Transform Indicator
The Fisher Transform Indicator is a technical analysis tool that helps convert prices into a Gaussian normal distribution. This allows traders to better identify turning points in the asset’s price and can highlight key trends and price waves within these trends. The indicator was conceived by John F. Ehlers, an author, trader, and engineer known for his groundbreaking contributions to technical analysis indicators.
Key Takeaways
- The Fisher Transform Indicator normalizes asset prices, making it easier to discern turning points.
- It can be applied not just to prices but to other indicators as well.
- Traders often look for extreme readings to signal potential price reversals or changes in indicator direction.
- Despite its advantages, seeking to normalize prices using this indicator may not always yield reliable signals as asset prices are not normally distributed.
Formula and How to Calculate the Fisher Transform Indicator
The Fisher Transform formula is quite intuitive and can be outlined as follows:
| Fisher Transform = 1/2 * ln((1 + X) / (1 - X))
Where:
- ln denotes the natural logarithm
- X represents the transformation of the price to a range between -1 and +1
To calculate it:
- Choose a lookback period, typically nine periods.
- Convert the prices in this range to values between -1 and +1, applying these to X within the formula.
- Apply the natural logarithm.
- Multiply the result by 0.5.
- Continuously repeat this process as each new period ends, adding/subtracting from the previous value accordingly.
How to Apply the Fisher Transform Indicator to Your Trades
Being an unbounded indicator, the Fisher Transform can yield extremes for extended periods. Around instances of extreme readings, a reversal might be forthcoming. It’s usually confirmed if the indicator direction shifts.
Additional Tips:
- Often paired with a signal line, a moving average helps to make the Fisher Transform produce reliable trade signals.
- Conservative traders use it along with trend analysis, making it effective in particular market conditions.
- It pairs well with other tools like the relative strength index (RSI) and moving average convergence/divergence (MACD).
Fisher Transform Indicator versus Bollinger Bands®
Both these indicators provide different perspectives on asset prices’ statistical behavior:
- Fisher Transform uses a Gaussian normal distribution whereas Bollinger Bands® use standard deviation.
- Bollinger Bands® overlay price charts, while the Fisher Transform appears separate but complements other analyses.
Limitations of the Fisher Transform Indicator
Although the Fisher Transform Indicator is valuable, it does come with inherent challenges:
- It can get noisy and may give false reversal signals.
- Extreme levels could change over time, making it tough to set static thresholds.
- Due to the natural shift in asset price distributions, the results may not always be reliable for unique assets.
What’s the Difference Between the Fisher Transform and MACD?
While the Fisher Transform focuses on normalizing asset prices, MACD relies on moving averages to measure market momentum. Traders consider the Fisher Transform to be potentially more precise due to highlighting specific market movements and possible trend reversals.
Technical Analysis Basics
Technical analysis involves evaluating past market data to forecast future price movements. Traders use key metrics like historical prices and trading volumes to chart and gauge market conditions, often with a plethora of indicators to guide entry and exit points.
What Are Technical Indicators?
These are tools that traders use to interpret and predict price movements. They analyze asset data—primarily historical prices and volumes. Common examples include the Fisher Transform Indicator, moving averages, RSI, and MACD.
The Bottom Line
Fisher Transform Indicator is a significant part of a trader’s toolkit, turning price data into a format that reveals potential reversals and trends more clearly. However, always use it in conjunction with other indicators to ensure a more comprehensive view and to minimize market risk exposure.
Related Terms: Gaussian normal distribution, price reversals, technical indicators, moving averages, relative strength index, MACD.
References
- Quantified Strategies. “John Ehlers Trading Strategy: The Instantaneous Trendline with Backtest”.
