Technical Indicators

Definition of 'Technical Indicator'

Any class of metrics whose value is derived from generic price activity in a stock or asset. Technical indicators look to predict the future price levels, or simply the general price direction, of a security by looking at past patterns. 

The price and market in trading are always changing. We can’t predict what will happen next. The price that seems stable could be down to the lowest point in an instant. Having a deep knowledge about chart patterns and technical indicators is essential in trading.These aspects could determine the success and failure. Keep an eye on the Chart indicators to avoid the big loss.
Technical indicators also play an important role in the analysis for take a trading decision. With simple mathematical tools, it becomes an important aspect to consider when trade.

There are several indicators available on the screen. What is the best then? Well, the answer is none of them is the best. As stated earlier, the world of  trading is dynamic. It's always changed and unpredictable. Indeed, there are several types of the indicator and they have its own characteristic. For a particular chart, different indicators can give various significant. For example, an oscillator is the best partner for ranging markets.

The best way is to combine all indicators to get a complete picture of the market. It might take time, but it provides a complete view of the current condition of the market.

Some technical indicators are used to confirm price action (lagging indicators), others are used to predict price action while some others are used as an alert or warning of a possible break on price action.

Lagging indicators

These indicators follow the price action, in other words they confirm what the price just did. The signals that come out of this type of technical indicators usually happen after the change in price begins. These types of indicators are also called trend-following indicators and work best during trending markets, where they allow traders to catch most of the move. During trendless conditions (sideways or ranging market) these types of indicators give many false signals.

Leading indicators

These indicators try to predict future price movements. They give signals before the actual price movement begins. These kinds of indicators work best during consolidation periods or trendless markets. During trending conditions, only signals in direction of the existing trend are advised to be taken. During up-trending conditions, leading indicators help us identify oversold conditions (price has falling enough and it is ready to continue its trend). During downtrending conditions, they help us identify overbought conditions (price has rallied enough, and now it is ready to continue its trend).
When using leading indicators it is also advisable to wait for the actual price movements before taking the indicator signal.
Most important lagging indicators: Moving Averages (MA) and Moving Average Convergence-Divergence (MACD).*
Most important leading indicators: Relative Strength Index (RSI), Stochastics, Commodity Channel Index (CCI) and Momentum.*
*Some of these indicators can be used both as a lagging indicator and as a leading indicator.

Sensitivity vs. Consistency

Before going through all the indicators it is important to understand the relationship between these two concepts. Every indicator represents price movements over a chosen period. Each indicator gives you the option to decide on how many periods you want to go back over to do the calculation. If we shorten the period, we will get more and earlier signals, but at the same time, the percentage of false signals will also increase. If we increase the number of periods, false signals will decrease, but the signal will get us in a trade later, giving up some profits.
It is up to the trader to select the approach that best suits his or her trading personality, trading style and objectives.

That it know the chart analysis is an essential part of technical analysis. On the other hand, the essential part of chart analysis is the use of the indicator. 

Typically, the Technical Indicators are divided into several categories,
They are -  

1. Trend Indicators - show trends.
2. Momentum Indicators - show trend strength/weakness.
3. Volatility Indicators - show magnitude of price fluctuations.
4. Volume indicators - show the level of trader's participation in the market.
5. Cycle Indicators - show repeating patterns in the market. 

No 1. Trend Indicators 

Trend indicators in chart reflect three tendencies in price movements:

Up moves, Down moves and Sideways price moves.

Trend indicators help defining the prevailing direction - trend - of the price moves by smoothing price data over a certain period of time.

In simple words, Trend indicators allow to visualize Trends in the market.


Trend Indicators

• Advance Decline Line (ADL)
• Average Directional Index (ADX)
• Average Directional Movement Index Rating (ADXR)
• Commodity Selection Index (CSI)
• Double Exponential Moving Average (DEMA)
• Heiken-ashi candlesticks
• Heiken-ashi ZoneTrade
• MACD
• Moving Averages: EMA, SMA and WMA
• Parabolic SAR
• Percentage Price Oscillator (PPO)
• Triple Exponential Moving Average (TEMA)
• Triple Exponential Moving Average (TRIX)

No. 2.  Momentum Indicators

Momentum indicators in chart records the speed of prices moving over certain time period. At the same time Momentum indicators track strength and weakness of a trend as it progresses over a given period of time: the highest momentum is always registered at the beginning of a trend, the lowest - at its end point.

Momentum Indicators

• Accumulative Swing Index (ASI)
• Advance Decline Ratio (ADR)
• Aroon Indicator
• Aroon Oscillator
• Chande Momentum Oscillator
• Commodity Channel Index (CCI)
• Intraday Momentum Index
• Gravity
• Linear Regression Slope
• MA Angle
• Mass Index
• Momentum
• Price Oscillator
• Random Walk Index
• Range Indicator
• Rate of Change (ROC)
• Relative Momentum Index
• Relative Strength Index (RSI)
• Smoothed Indexed Rate of Change (SIROC)
• Stochastic
• Stochastic RSI
• Stochastic Momentum Index
• Swing Index
• Ultimate Oscillator
• Williams %R
• Williams' Accumulation-Distribution

How to trade with Momentum Indicators

With Momentum indicators traders look for controversy between chart prices and Indicator suggestions:

A. directional divergence between the price and momentum signals of a trend's developing weakness.

B. price spikes that occur during weak momentum, are the last warning signals of the trend change.

C. also trend change should be expected during sideways moving prices and controversially strong momentum.

Momentum indicators, such as RSI and Stochastic, are favorite indicators for non-trending markets. Momentum indicators ideally gauge whether the market is overbought or oversold during its non-trending state, and highlight potential reversal points before those actually occur.

No. 3. Volatility Indicators

Volatility indicators show the size and the magnitude of price fluctuations.
In any market there are periods of high volatility (high intensity) and low volatility (low intensity).

These periods come in waves: low volatility is replaced by increasing volatility, while after a period of high volatility there comes a period of low volatility and so on.

Volatility indicators measure the intensity of price fluctuations, providing an insight into the market activity level.

Volatility Indicators:

• Average True Range (ATR)
• Bollinger Bands (BB)
• Chandelier Exit
• Bollinger Bands Width
• Chaikin Volatility (CHV)

 
The methodology of using Volatility indicators

Low volatility suggest a very little interest in the price, but at the same time it reminds that the market is resting before a new large move. Low volatility periods are used to set up the breakout trades. For example, when the bands of the Bollinger bands indicator squeeze tight, traders anticipate an explosive breakout way outside the bands limit.

A rule of thumb is: a change in volatility leads to a change in price.
Another thing to remember about volatility is that while a low volatility can hold for an extended period of time, high volatility is not that durable and often disappears much sooner.

No. 3. Volume Indicators

Volume indicators are used to determine investors' interest in the market. High volume, especially near important market levels, suggests a possible start of a new trend, while low volume suggests traders uncertainty and/or no interest in a particular market.

In chart Volume data represents total number of quotes for the specified time period.

Volume Indicators:

• Acceleration Bands
• Market Facilitation Index
• Volume
• Chaikin Money Flow (CMF)
• Accumulation Distribution
• Volume Oscillator (PVO)
• Demand Index
• On Balance Volume (OBV)
• Money Flow Index (MFI)
• VWAP (Volume Weighted Average price)

The methodology of using Volume indicators

When Volume increases it indicates a growing interest in the market, therefore it may strengthen a main trend or start a new trend;

When Volume decreases it indicates that interest in the market is decreasing, which calls for either a trend reversal or temporary market consolidation;

Sudden and vigorous increase in Volume may signal for an upcoming reversal, while gradual decreasing in Volume may still be supported by rapid price moves.

No. 4. Cycle indicators

A cycle in the market is determined by a series of repeating patterns.
These patterns are, as a rule, dedicated to certain market events, such as seasons, simple day counts, event-to-event sequence, market theories and formulas and so on.

 
The list of Cycle indicators includes:

• Detrended Price Oscillator (DPO)
• Elliott waves
• Schaff Trend Cycle
• Wolfe waves
• Fibonacci Time Zones
• Cycle Lines
• Fourier Transform
• MESA Sine Wave Indicator
• Pivot Points
• Etc. 

Summary Of Indicator

Using Technical Indicators To Develop Trading Strategies

Choosing Indicators to Develop a Strategy What 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.

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.

Each indicator has its imperfections. This is why traders combine many different indicators to "screen" each other. As you progress through your trading career, you will learn which indicators you like the best and can combine them in a way that fits your trading style.

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 back test 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.