- Type of Indicator: Statistical
- Creator: John Ehlers
- When Created: 2002
- First Mentioned In: November 2002 Issue of Technical Analysis of Stocks & Commodities Magazine
What Is The Fisher Transform?
The Fisher Transform is a technical analysis indicator developed to help traders identify potential trend reversals and provide clear buy and sell signals.
The technical indicator is based on the idea that prices do not have a Gaussian probability function. According to Wikipedia, “a normal distribution or Gaussian distribution is a type of continuous probability distribution for a real-valued random variable.” In more simple terms, it uses price data to visualize statistical probabilities.
The tool “transforms” prices into a Gaussian normal distribution to create a sharper and more responsive oscillator that can better identify price reversals. The turning points the tool generates may be used to determine market entry and exit points.
The unbounded oscillator works based on a standard deviation. The majority of price action takes place within readings of -2 to 2. Beyond such extremes indicates a powerful move, but a higher probability of a reversal in the near term.
How Do You Read The Fisher Transform?
The Fisher Transform provides traders with valuable information about potential turning points in a market.
By identifying these turning points, traders can better gauge the strength of the prevailing trend and make more informed decisions about when to enter or exit positions.
In addition to identifying potential trend reversals, the tool can also help traders confirm the strength of a trend.
If the indicator consistently stays above the trigger line during an uptrend or below the trigger line during a downtrend, it can signal the continuation of the prevailing trend.
How Does The Tool Work?
The Fisher Transform uses the natural logarithm function and the inverse Fisher Transform to convert price data into a normal distribution, allowing traders to identify potential turning points in the market.
The Fisher Transform oscillates around the zero line, with extreme values indicating potential trend reversals.
How Is The Fisher Transform Calculated?
Determine the price range within a given period (usually 10 or 14 periods).
Calculate the value of the Fisher Transform using the following formula:
Fisher Transform = 0.5 * ln[(1 + X) / (1 – X)]
where X = [(price – lowest low) / (highest high – lowest low) – 0.5] * 2
Smooth the Fisher Transform values using a moving average or another smoothing method.
How Do You Use The Fisher Transform?
Crossovers: A buy signal occurs when the Fisher Transform line crosses above the trigger line (usually a 1-period or 2-period moving average of the Fisher Transform values), indicating a potential bullish reversal. A sell signal occurs when the Fisher Transform line crosses below the trigger line, indicating a potential bearish reversal.
Divergence: If the price of an asset moves in one direction while the Fisher Transform moves in the opposite direction, it may signal a potential trend reversal. Bullish divergence occurs when the price makes a lower low, but the indicator makes a higher low. Bearish divergence occurs when the price makes a higher high, but the indicator makes a lower high.
Extreme Values: The Fisher Transform can reach extreme values, which may indicate potential trend reversals. A buy signal may be generated when the indicator reaches an extremely negative value and starts to move higher. Conversely, a sell signal may be generated when the indicator reaches an extremely positive value and starts to decline.
Additional Trading And Risk Management Tips
Combine the Fisher Transform with other technical indicators or chart patterns to improve the accuracy of your trading signals.
Be cautious when relying solely on the indicator, as it can generate false signals in certain market conditions, such as strong trending markets or volatile, choppy markets.
Adjust the lookback period and the smoothing method to suit your specific trading style and the asset you are analyzing. Shorter periods may generate more signals but mayalso be more prone to false signals.
Practice proper risk management techniques to protect your investments, and always consider other factors in addition to the Fisher Transform when making trading decisions.
Test the Fisher Transform on historical data to evaluate its effectiveness for your specific trading style and market conditions before incorporating it into your live trading strategy.
Be patient and disciplined when using the Fisher Transform, waiting for clear signals before entering or exiting trades. Avoid overtrading or making impulsive decisions based on ambiguous or conflicting signals.
Practice using the technical indicator with TradingView.