Inequality Index: Meaning, Formula and Example

What is the inequality index?

The disparity index is a technical indicator that measures the relative position of an asset’s most recent closing price to a selected moving average and reports the value as a percentage.

Understanding the Inequality Index

The introduction of the disparity index – at least to European and American traders – is attributed to Steve Nison, who discussed it in his book Beyond Candlesticks: New Japanese Charting Techniques Revealed (John Wiley & Sons, 1994). “A commonly used Japanese tool is the inequality index,” he wrote.

As a formula, the equation for the disparity index would be expressed as:

Disparity Index = (Current Market Price − n -PMAV) n -PMAV × 100 where: n -PMAV = n -Period moving average value \begin{aligned}&\text{Disparity Index}=\frac{\text{(Current Market Price} -n\text{-PMAV)}}{n\text{-PMAV}}\times100\\&\textbf{where:}\\&n\text{-PMAV}=n\text{-Period moving average value} \end{align}

,Inequality index=a-PMAV(Current market price−a-PMAV),x100where:a-PMAV=n-Period moving average value,

A value greater than zero – a positive percentage – shows that the price is rising, indicating that the asset is gaining upward momentum. Conversely, a value less than zero – a negative percentage – can be interpreted as a sign that selling pressure is increasing, forcing the price to fall. A value of zero means that the asset’s current price exactly matches its moving average.

Similar to the Rate of Change (ROC) indicator (another momentum indicator), the disparity index generates important signals when it crosses the zero line because it is an early signal of an impending rapid change in trend, and hence the price. Extreme values ​​in either direction can indicate that a price correction is about to occur.

Disparity index example

Contrarian investors especially like the inequality index. The extreme values ​​of this indicator can be a very useful tool for them to predict periods of exhaustion – that is, whether an asset is overbought or oversold, and therefore vulnerable to a sudden change.

Once the price is excessively pushed in one direction, there are very few investors to take the other side of the trade when the participants want to close their position, which eventually leads to a price reversal. The disparity index is therefore a good warning indicator when a trending market reaches an extreme. and may be ripe for a correction or a reversal.

Just like other momentum indicators, a trader should use the disparity index indicator in conjunction with other tools when trying to spot potential reversals or confirm a trend.

The Bottom Line

The disparity index, which is presented as a percentage, measures the distance between the latest closing price of an asset and the moving average.

When the disparity index exceeds zero, it means that the price is rising and has closed above the moving average. If, conversely, the volatility index is negative (less than zero), it indicates that the price of an asset has fallen and this is in line with its moving average. The disparity index provides investors with insight into price momentum and potential reversals.