Master the essence of the Bias indicator: Understand market psychology and buy/sell timing through divergence rate

Market Psychology Investors Need to Understand — The Core Logic of Bias Ratio

Stock market fluctuations ultimately stem from participants’ expectations. When most people are bullish, prices rise; when most are bearish, prices fall. Bias Ratio (BIAS) is a technical tool used to capture these expectation changes.

In simple terms, Bias Ratio reflects the deviation between the stock price and its moving average. It is expressed as a percentage, helping traders determine whether a stock is overbought or oversold.

Imagine a bumper harvest year in the agricultural market: when rice prices far exceed the average level of previous years, farmers rush to sell due to concerns about oversupply; buyers believe prices have peaked. This psychological phenomenon is exactly the same in the stock market—when stock prices are far above the average level, investors tend to sell; when prices are far below, they tend to buy.

Understanding Positive and Negative Bias Ratios: Signals of Overbought and Oversold Markets

Based on the relationship between the stock price and the moving average, Bias Ratio is divided into two categories:

Positive Bias Ratio: Stock price is above the moving average, indicating an overbought condition and potential overheating

Negative Bias Ratio: Stock price is below the moving average, indicating an oversold condition and possible excessive selling

Both situations suggest that the market may face a reversal—extreme deviations will eventually revert to normal.

Mathematical Basis and Calculation Method of Bias Ratio

To use the bias indicator for trading decisions, first understand its calculation logic:

Calculation formula: N-day BIAS = (( Closing Price of the Day - N-day Moving Average) / N-day Moving Average

where N-day moving average is the average closing price over the past N trading days. Since the moving average itself has a lag, the derived Bias Ratio also has a time delay, which is a limitation to be aware of when using this indicator.

How to Set Up the Bias Indicator for Maximum Effectiveness

) Step 1: Choose an appropriate moving average period

The sensitivity and smoothness of the Bias Ratio mainly depend on the selected MA period:

• Short-term periods (5, 6, 10, 12 days): respond quickly to price changes, suitable for capturing short-term volatility, but prone to false signals
• Mid-term periods (20, 60 days): balance sensitivity and stability, suitable for medium-term traders
• Long-term periods (120, 240 days): smooth data with less noise, ideal for long-term trend judgment

Step 2: Determine BIAS parameters and threshold settings

Common Bias Ratio parameters are 6-day, 12-day, 24-day. Parameter selection should consider:

• Stock characteristics: Highly active stocks are suitable for short periods to ensure indicator sensitivity
• Market environment: In a bear market, negative Bias Ratios may reach deeper extremes; in a bull market, positive Bias Ratios may be higher
• Personal style: Aggressive traders tend to prefer short periods; conservative traders prefer longer periods

Thresholds should also be adjusted based on historical volatility. For example, a 5-day Bias Ratio can be set at ±2% to 3% in normal markets, but during high volatility periods, higher thresholds are needed to avoid frequent false signals.

Practical Application: Using the Bias Indicator to Precisely Identify Entry and Exit Points

Basic operational logic

After setting positive and negative thresholds, the application rules of the Bias indicator are straightforward:

Bias exceeding the positive threshold → Overbought, risk of decline, consider selling or reducing positions

Bias below the negative threshold → Oversold, potential for upward momentum, consider buying or increasing positions

Advanced application: Multi-moving average cross-verification

Relying on a single period Bias Ratio can lead to mistakes. A more robust approach is combining 5-day and 20-day Bias Ratios for cross-validation:

• When the 5-day Bias is deeply negative, but the 20-day Bias remains moderate—indicating short-term oversold conditions without breaking the medium-term trend
• When both Bias ratios show extreme values simultaneously—suggesting a near-term turning point

Key Signal: The Practical Value of Divergence Phenomena

Bias divergence is an important clue for trend reversal:

• Top divergence: Price hits new highs but Bias does not confirm with new highs, indicating weakening upward momentum and warning of a potential top
• Bottom divergence: Price hits new lows but Bias does not confirm with new lows, indicating exhausted downward momentum and signaling an imminent rebound

Such divergence is often more reliable than pure numerical extremes.

Limitations of the Bias Indicator That Cannot Be Ignored

Typical situations where the indicator fails

1. In choppy markets

When stocks are in a prolonged narrow range with minimal fluctuations, the Bias Ratio loses its reference value because there is insufficient deviation space for it to work effectively.

2. Lagging risk

Since the Bias Ratio relies on historical average data, it reacts slowly to sudden positive or negative news, potentially causing missed opportunities in sell decisions. Therefore, it is more suitable as a reference for buying rather than selling.

3. Market capitalization and liquidity effects

Large-cap stocks tend to have more stable fluctuations, making Bias Ratio judgments more accurate; small-cap stocks are more volatile, with frequent extreme Bias values, which can mislead if used alone.

Practical Suggestions to Improve Trading Success Rate

Combine multiple indicators for verification

Bias should never be used in isolation. It is recommended to combine it with stochastic indicators (KD) for short-term rebound confirmation, or with Bollinger Bands for oversold buy signals. The combination of Bias Ratio + Bollinger Bands is especially effective in confirming rebound points.

Adjust parameters flexibly

Too short parameters are overly sensitive and prone to false signals; too long parameters react slowly and may miss opportunities. Traders should continuously optimize parameters based on their risk tolerance and trading cycle.

Adjust expectations based on stock quality

High-quality stocks tend to rebound quickly after declines due to strong demand; low-quality stocks may remain dormant for a long time after falling. Using the same Bias Ratio standards to judge different quality stocks can lead to biased decisions.

Summary

As a fundamental tool within the Bias Ratio system, the Bias indicator is widely used for its intuitiveness and ease of use. However, technical indicators are ultimately just reflections of the market and cannot replace fundamental analysis and risk management. Successful trading requires the interaction of indicators, market sentiment, and capital management, rather than mechanical application of a single tool. Traders interested in technical analysis should keep learning and experimenting to find the methodology that suits them best in the complex market environment.