A Brief Introduction to COST2 (Chande Oscillator, Short Term #2)

Tushar Chande
May 8, 2021

Is the stock or ETF or market trending?  This seemingly simple question can be difficult to answer.

Among other factors, the answer depends on the time frame being used; and the answer could be different in different time frames.  For example, prices could be trending in opposite directions in different time frames.

The annoying bit is that it is easy to recognize the trend after the fact.  Hence, we have built tools to confirm if a market is trending to help answer the question as early as possible.  

One approach is to get a composite answer by using several different indicators, or several different parameter combinations of the same indictor.  You then have the problem of choosing and weighting these different indicators or sets.

We have solved this problem by building a composite indicator, the Chande Oscillator Short Term #2 (COST2) using a total of 41 internal comparisons. These carefully weighted comparisons provide a comprehensive check on trend strength and directions.

It is important to emphasize that we mean “short-term” in the relative sense when using daily data. The COST2 indicator can be used on any timeframe, from intra-day on upward.

Observe that the COST2 indicator (see Figure 1) uses a range from +100 (very strong up-trends) to -100 (very strong down-trends). Note that when the trend is strong, the values are “pinned” at +100 (or -100) to reinforce the confirmation. For practical applications, we have drawn reference lines at +50 and -50, implying that the trend is broadly higher (or lower) when the values are above +50 (or below -50).

Naturally, we can debate ad nauseum whether we could have used different weights or used other indicators.  The decision-making process for trading requires only that you build heuristics or rules based on your style or experience that support your analysis.

Since the range is +100 to -100, and the neutral zone is from +50 to -50, a variety of trend-following or counter-trend strategies can be built using this indicator.    

So, we encourage you to experiment with COST2 to find your comfort level.

Figure 1:  This daily chart is for Lam Research (LRCX).  The Chande Oscillator Short Term #2 (COST2) (lower panel) is plotted on a scale of+100 to -100 and uses 41 separate internal checks to build a comprehensive gauge of trend strength and direction.  The trend is broadly higher when COST2 is greater than +50 (horizontal green line),and broadly lower when it is < -50 (horizontal red line). The purple bands are the 20-day, 2-standard deviation Bollinger Bands, the recommended default configuration.  The bands are primarily for identifying overbought/oversold (OB/OS) conditions, so that the predominant expectation is a reversion to the mean (moving average) when prices reach the bands, except for the case when the markets trend by “walking” along the bands.  Observe that prices rebound or retreat from near the bands, confirming their OB/OS bias.  Thus, the bands are not tools for identifying trends, since it is not clear when the market will decide to take a walk along the bands.  This is where COST2 comes in; it can be used to confirm breakouts.
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