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Center of Gravity

Parameters:

  • Source: A dropdown menu to select the data source for the calculation. Options include:
    • Open Price: Uses the opening price of each period.
    • High Price: Uses the highest price of each period.
    • Low Price: Uses the lowest price of each period.
    • Close Price: Uses the closing price of each period.
    • Volume: Uses the trading volume of each period.
    • Weighted: A weighted price is typically calculated as (High + Low + Close + Close) / 4.
    • Typical: Calculated as (High + Low + Close) / 3.
    • Median: Calculated as (High + Low) / 2.
  • Periods: The number of periods used to calculate the Center of Gravity is commonly set to 10. This helps identify the balance point of the price data over the specified period.

Style:

  • Customizable line style and color for the Center of Gravity line.

The Center of Gravity (COG) indicator was created by John Ehlers. It serves as a tool in technical analysis to help pinpoint potential turning points in price movements at the earliest opportunity. This enables traders and analysts to anticipate market changes more effectively.An oscillator derives its values from the sum of prices over a certain number of bars, divided by the total by the sum of the prices. Essentially, the COG indicator attempts to identify the center where the price is expected to return, hence its name, implying a mean reversion theory at its core.

How COG Works: The COG calculation is based on the statistical concept of the center of gravity of a distribution, which is the point at which the distribution would balance. In the context of financial markets, the COG uses the prices of the past bars to determine the balance point. The mathematical representation involves polynomial regressions, which are used to fit the recent price action, and the end point of this calculation is considered the 'center of gravity.'

The indicator is plotted as a single line or sometimes together with an additional signal line, which is the moving average of the COG line itself. When the price deviates significantly from the COG line, it indicates that the price may soon revert to the mean the COG line represents.

Key Aspects of COG:

  • Mean Reversion: The COG is a mean reversion indicator, which posits that asset prices and historical returns will eventually revert to the entire dataset's long-run mean or average level.
  • Leading Indicator: The COG is considered a leading indicator because it is designed to forecast future price movements. It can signal potential reversals before they occur in price action.
  • Oscillator: As an oscillator, the COG fluctuates above and below a zero line, which can aid in identifying overbought and oversold conditions.

Application of COG: Traders often look for the points where the price crosses the COG line as potential entry or exit signals. If the price crosses above the COG line, it may be a signal to buy or cover shorts. Conversely, if the price crosses below the COG line, it may be a signal to sell or short.

Additionally, when the COG line changes direction, it can signal a potential reversal. This is because it indicates that the mean price, as calculated by the COG formula, is changing direction, suggesting that the overall momentum of the price is shifting.

Limitations:

  • Market Sensitivity: The COG can be too sensitive to recent price changes, leading to false signals and noise.
  • Repainting: The COG can "repaint" itself as new data comes in, meaning past COG lines can change with new price information, which could mislead backtesting results.
  • The polynomial regression involved in calculating the COG is complex and may not be as transparent to some traders, making it a less intuitive tool to use.

Conclusion: The Center of Gravity indicator is a complex but potentially powerful tool in the arsenal of a technical trader. Attempting to determine where the price is likely to move towards can warn traders early about potential trend reversals. However, its utility is increased when used in conjunction with other forms of analysis, including trend and momentum indicators, to filter out false signals. It requires a thorough understanding and should be used by those who are comfortable with its repainting nature and can integrate its mean reversion logic into their overall trading strategy.