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Technical Analysis Indicators. What They Are and How to Use Them.
Definition of 'Technical Indicator'
Technical analysis indicators are the basis of technical analysis which is used to determine future financial, stock or economic trends. Technical indicators are used to help the investor know when to enter or exit a trade, to be able to make a profit. Simply put, technical indicators look at price information and translate it into simple, easy-to-read signals that can help the investor determine the correct time as to when to buy and when to sell.
A technical indicator is a result of mathematical calculations based on indications of combinations of price, time and volume. The values obtained are used to forecast probable price changes. It is a series of data points that are derived by applying a formula to the price data of a security. This price data applies to any combination of the open, high, low, or close over a period of time. The price data is entered into the formula and a data point is produced.
Also, technical analysis indicators, collectively called "technical s," are distinguished by the fact that they do not analyze any part of the fundamental business, like earnings, revenue and profit margins. The active trader in the market uses technical indicators most extensively because they are designed primarily for analyzing short-term price movements. If you are a long-term investor, most technical indicators are of little value, as they do not cover what is happening in the underlying business. The long-term investor is best off analyzing the long-term trend by identifying good entry and exit points for the stock.
Deriving Technical Analysis Indicators
Technical analysis indicators are derived from technical charts – which can be graphical or pictorial representations of the market activity in terms of upward or downward movements in stock prices over a period of time. However, some technical chart formations may also take into account trading volumes in the calculations. Mathematically, a technical chart is a plot of a set of price data (on the vertical axis) and a function of time (on the horizontal axis). This price data can include a stock’s opening price, closing price, the day’s high or low price, average price, or a combination of these. The plotted data points on the chart can show as individual points or as small bars. When all the data points on the chart are joined, a wave-like pattern is obtained. This pattern is then subjected to technical analysis by experts, who apply standard mathematical formulae to these price movements in order to arrive at technical indicators, from which they can predict the future market price of a stock or its market trend (upward/downward movement).
Types of Technical Indicators
There are many different technical indicators available, and it is important for the investor to choose those that are applicable to his/her type of trade and trading method. There are two main categories that technical indicators fit into, which are leading indicators and lagging indicators. Leading indicators change before the underneath commodity changes, whereas lagging indicators are usually behind, or follow the event. The main benefits of leading indicators is the early signaling for entry and exit, it generates more signals and allows more opportunities to trade in trading markets. Lagging indicators follow the price action and are also known as trend-following indicators. Trend-following indicators work best when markets or securities develop a strong trend and signals traders to take long position and keep holding the position as long as the trend is intact.
List of Indicators
Volume indicators help to confirm the strength of the trend.• Volume Oscillator
• On Balance Volume
• Chaikin Oscillator
• Money Flow Index
• Compare Range and Volume
2/Momentum Indicators
• Accumulation/Distribution
• Money Flow Index
• On Balance Volume
• Price and Volume Trend
• Volume Rate of Change
Price Indicators are computed by prices data. A subcategory of Price Indicators is oscillators.
Common Oscillators
Oscillators are indicators that are usually computed from prices and tend to cycle or “oscillate” within a fixed or limited range.
• Average True Range
• Chaikin Oscillator
• Chaikin Volatility
• DeMarker
• Detrended Price Oscillator
• Elder-Rays
• Envelopes
• Force Index
• Ichimoku Kinko Hyo
• Momentum
• Moving AverageConvergence/Divergence (MACD)
• Inventor of MACD - Gerald Appel
• Established the MACD Histogram - Tom Aspray
• Moving Average of Oscillator
• Price Rate of Change
• RelativeStrength Index
• Relative Vigor Index
• Slow Stochastic
• Stochastic Oscillator
• Ultimate Oscillator
• Williams` Percent Range
3/Trend Indicators
• Average Directional Movement Index
• Accumulation Swing Index
• BollingerBands
• Commodity Channel Index (CCI)
• Directional Movement Index (DMI)
• Mass Index
• Moving AverageConvergence/Divergence (MACD)
• Inventor of MACD - Gerald Appel
• Established the MACD Histogram - Tom Aspray
• Moving Average
• Parabolic SAR
• Pivot Points Support and Resistance Lines
• Standard Deviation
• TRIX indicator
• ZigZag
• Williams` Accumulation/Distribution
• Hindenburg Omen
4/Bill Williams
• Acceleration/Deceleration
• Alligator
• Awesome Oscillator
• Fractals
• Gator Oscillator
• Market Facilitation Index
5/Volatility Indicators
• BollingerBands
• Volatility
• Chaikin Volatility
• Volatility Ratio
• Average True Range
6/Number Theories
• Gann numbers
7/Waves Theory
Other Various Market Indicators
• VIX Spikes
• Five-Week Expiration Cycle
• Hedging
• The Fourth Quarter
• Five-Month Losing Streaks
Economic Indicators
• Consumer Spending
• Pending Home Sales
• Copper
The Benefits of a Technical Indicator
A technical indicator can provide unique perspective on the strength and direction of the underlying price action within the stock market. Its main functions are to alert, to confirm and to predict. When looking at price movement on a computer screen the stock prices continually fluctuate, and, in most cases, it is difficult to discern a pattern of when to enter or exit a trade. However, technical analysts, to smooth out the data and make it easier to understand, are able to plot the movements of the stock on a chart. By plotting the highs, lows, open, close and average prices, then we can understand the movements of very volatile stock. The data becomes smoothed out to show a clearer picture.Other benefits of technical indicators to the investor are:-
• Determining the support and resistance levels. This will indicate if a stock’s price has dropped lower (support levels) or has climbed higher (resistance levels).
• That some indicators can help determine the future price of a share.
• Technical indicators help in establishing trends (upward or downward), which are critical for both traders and investors.
• Technical indicators always alert a technical analyst if any major price action or/and volatility is about to occur in a stock’s price.
Key Points about Using Technical Analysis Indicators
1. Indicators simply provide “indication,” and many investors tend to forget this fact and ignore the price action of a security and focus solely on an indicator. 2. An indicator filters price action with formulas. As such, they are derivatives and not direct reflections of the price action. Any analysis of an indicator should be taken with the price action in mind.3. The same indicator may exhibit different behavioral patterns when applied to different stocks.
4. When indicators generate buy and sell signals, the signals should be taken in context with other technical analysis tools.
5. The same indicator may exhibit different behavioral patterns when applied to different stocks.
6. Choosing an indicator to use for analysis is difficult as there are hundreds in use today, and more being created every week.
7. Choose indicators that complement each other, instead of those that move in unison and generate the same signals. Two or three indicators are usually sufficient in most cases.
CONCLUSION
Use two or three indicators to analyze stock prices, as using just one indicator may give you a false signal. With time you will develop the art of judging profitable trades using technical indicators.
Each technical indicator provides unique information. You will find you will naturally gravitate toward specific technical indicators based on your trading personality, but it is important to become familiar with all of the technical indicators at your disposal.
You should also be aware of the one weakness associated with most technical analysis indicators. Because technical indicators look at historical price data, they do lag behind current market data to an extent, but they still provide invaluable information. Lagging indicators follow the price action and are known as trend-following indicators and tend to lead to many false signals. They give late signals that cause late entry which is a disadvantage to investors.
To compensate for this, leading indicators can be helpful. They will generate more signals and allow more opportunities to trade in trading markets but on the other hand, more signals and earlier signals mean that the changes of false signals will also increase which could lead to an increase in potential losses.
"Success is simple. Do what's right, the right way, at the right time".
Summary Of Using Indicator.
Using Technical Indicators To Develop Trading Strategies
Choosing Indicators to Develop a StrategyWhat type of indicator a trader uses to develop a strategy depends on what type of strategy he or she intends on building. This relates to trading style and risk tolerance. A trader who seeks long-term moves with large profits might focus on a trend-following strategy, and, therefore, utilize a trend-following indicator such as a moving average. A trader interested in small moves with frequent small gains might be more interested in a strategy based on volatility. Again, different types of indicators may be used for confirmation. Figure 2 shows the four basic categories of technical indicators with examples of each.
The four basic categories of technical indicators.
Summary: Common Chart Indicators
Everything you learn about trading is like a tool that is being added to your trader's toolbox. Your tools will give you a better chance of making good trading decisions when you use the right tool at the right time.
Bollinger Bands.
- Used to measure the market's volatility.
- They act like mini support and resistance levels.
Bollinger Bounce
- A strategy that relies on the notion that price tends to always return to the middle of the Bollinger bands.
- You buy when the price hits the lower Bollinger band.
- You sell when the price hits the upper Bollinger band.
- Best used in ranging markets.
Bollinger Squeeze
- A strategy that is used to catch breakouts early.
- When the Bollinger bands "squeeze", it means that the market is very quiet, and a breakout is eminent. Once a breakout occurs, we enter a trade on whatever side the price makes its breakout.
MACD
- Used to catch trends early and can also help us spot trend reversals.
- It consists of 2 moving averages (1 fast, 1 slow) and vertical lines called a histogram, which measures the distance between the 2 moving averages.
- Contrary to what many people think, the moving average lines are NOT moving averages of the price. They are moving averages of other moving averages.
- MACD's downfall is its lag because it uses so many moving averages.
- One way to use MACD is to wait for the fast line to "cross over" or "cross under" the slow line and enter the trade accordingly because it signals a new trend.
Parabolic SAR
- This indicator is made to spot trend reversals, hence the name Parabolic Stop And Reversal (SAR).
- This is the easiest indicator to interpret because it only gives bullish and bearish signals.
- When the dots are above the candles, it is a sell signal.
- When the dots are below the candles, it is a buy signal.
- These are best used in trending markets that consist of long rallies and downturns.
Stochastic
- Used to indicate overbought and oversold conditions.
- When the moving average lines are above 80, it means that the market is overbought and we should look to sell.
- When the moving average lines are below 20, it means that the market is oversold and we should look to buy.
Relative Strength Index (RSI)
- Similar to the stochastic in that it indicates overbought and oversold conditions.
- When RSI is above 70, it means that the market is overbought and we should look to sell.
- When RSI is below 30, it means that the market is oversold and we should look to buy.
- RSI can also be used to confirm trend formations. If you think a trend is forming, wait for RSI to go above or below 50 (depending on if you're looking at an uptrend or downtrend) before you enter a trade.
Average Directional Index (ADX)
- The ADX measures how strong a trend is.
- It fluctuates from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend.
- ADX can be used as confirmation whether the pair could possibly continue in its current trend or not.
- ADX can also be used to determine when one should close a trade early. For instance, when ADX starts to slide below 50, it indicates that the current trend is losing steam.
Conclusion
Indicators alone do not make trading signals. Each trader must define the exact method in which the indicators will be used to signal trading opportunities and to develop strategies. Indicators can certainly be used without being incorporated into a strategy; however, technical trading strategies usually include at least one type of indicator. Identifying an absolute set of rules, as with a strategy, allows traders to backtest to determine the viability of a particular strategy. It also helps traders understand the mathematical expectancy of the rules, or how the strategy should perform in the future. This is critical to technical traders since it helps traders continually evaluate the performance of the strategy and can help determine if and when it is time to close a position. Traders often talk about the Holy Grail - the one trading secret that will lead to instant profitability. Unfortunately, there is no perfect strategy that will guarantee success for each investor. Each trader has a unique style, temperament, risk tolerance and personality. As such, it is up to each trader to learn about the variety of technical analysis tools that are available, research how they perform according to their individual needs and develop strategies based on the results.
