Introduction
Within stock trading, it’s only a matter of time until you come across technical indicators such as the likes of moving averages, OBV, MACD, and more.
Knowing how these work is important so that you can glean a sense of what to use and where.
Definition of technical indicators
Technical indicators are pattern-based or heuristic signals that price, volume, and the open interest of securities or contracts may produce, which traders who follow technical analysis use.
The role of technical indicators in market analysis
The role they play is usually that of analyzing past data to predict future movements.
Brief history and evolution of technical indicators
Technical analysis can be traced as far back as ancient Greece or Rome, but it was only the 1900s that first saw the advent of most technical indicators we use, like moving averages and so on.
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Fundamentals of Technical Indicators
There are many indicators out there catering to various aspects of technical analysis, but their fundamentals mostly stay the same.
What technical indicators measure
As we said earlier, technical indicators measure historical and current information to predict price movements in the future or to just confirm trends that are already happening.
The idea is to look for patterns that could indicate substantial shifts in price.
How technical indicators are calculated
There’s a lot of math that goes into calculating these indicators with every sort of formula you can imagine.
Some are basic, like simple moving averages, which are literally just the average of every price over a certain period, whereas others are difficult, like the ADX and more.
Leading vs. lagging indicators
Leading indicators use the existing price data to predict whatever movements the price may take in the future.
The importance of timeframes in indicator analysis
Time frames are basically the length of the period that you want to look back on for any stock price information.
The general rule is that the longer you look back, the better the reliability of the signals given, so yes, they’re very important.
Types of Technical Indicators
The amount of technical indicators out there is many, but here we’ll just boil them down for you to make it easier for you to identify them for yourself.
Trend Indicators
So what are trend indicators even supposed to be? Well, they’re just meant to be this objective measure of trend direction, basically.
Moving Averages (Simple, Exponential, Weighted)
Moving averages are like the bread and butter of stock trading, and they’re just averages taken of the price over a certain period of time, and depending on the type of moving average, equal weighting can be attributed to every price or more weighting to the latest prices.
Moving Average Convergence Divergence (MACD)
The MACD helps investors identify price trends and entry points for purchasing and selling and also trend momentum, and it does that by showing relationships between two EMAs, or exponential moving averages.
Average Directional Index (ADX)
The ADX is what’s known as an oscillator, and its values can fluctuate from zero to 100. Readings below 20 indicate weak trends, whereas readings over 50 signal strong trends.
Parabolic SAR
The Parabolic SAR is used to determine which price direction the asset is moving towards while simultaneously drawing attention to when that price direction changes.
Momentum Indicators
Momentum indicators tend to be used as a way to find out how strong or weak a trend is.
Relative Strength Index (RSI)
The RSI tells whether an asset is overbought or oversold within the market, and its readings range from zero to 100.
Stochastic Oscillator
Like the RSI, the Stochastic Oscillator is used to identify overbought and oversold signals; the only difference lies in how it’s calculated and its incorporation of the %K and %D lines.
Commodity Channel Index (CCI)
The CCI can indicate overbought and oversold conditions as well, but it’s more commonly used for spotting new trends and trend weaknesses through divergences.
Williams %R
The values on this indicator range from zero to -100, and like the rest, it shows overbought and oversold signals and potential market reversals.
Volume Indicators
As the name suggests, these indicators focus more on volume than price.
On-Balance Volume (OBV)
On balance volume offers this running total of an asset’s trading volume and can indicate whether this volume is flowing out or in off any given currency pair or security.
Accumulation/Distribution Line
The A/D line uses both the price and the volume actually to evaluate how strong a stock’s price trend can be while spotting possibly trend reversals.
Chaikin Money Flow
The CMF incorporates a 10- and 3-day EMA of the A/D line and uses the difference between their values to find positive and negative money flows.
Volume Rate of Change
The VROC measures how quickly trading volume changes across a certain period of time so that investors know whether the volume is increasing or decreasing.
Volatility Indicators
Volatility indicators are just that—indicators for measuring volatility, like whether it’s high or low.
Bollinger Bands
Bollinger Bands were developed during the 1980s to aid investors or traders in gauging market volatility and identifying when stocks are poised to fall or rise.
Average True Range (ATR)
The ATR measures market volatility through the decomposing of the whole range of an asset’s price for a certain period.
So higher volatility has a higher ATR reading, whereas a lower ATR reading represents lower volatility naturally.
Keltner Channels
Keltner Channels are just volatility-based bands or lines, which are three, to be precise, with two placed on either side of a stock price and one in the middle, all to aid in finding the direction of certain trends.
Standard Deviation
Standard deviation happens to be a statistical measurement that identifies how far individual points within a dataset are dispersed from the mean of that particular set.
If the data points are far from that mean, then there’s a higher deviation in that data set.
Breadth Indicators
Breadth indicators are simply mathematical formulas capable of measuring the number of declining and advancing stocks or their volume to calculate how much participation there is within the price movements of a stock index.
Advance/Decline Line
The advance and decline line on a daily basis plots the difference between the amount of declining and advancing stocks.
McClellan Oscillator
The McClellan oscillator is like the advance and decline line, except it’s more famously used by the financial analysts at the New York Stock Exchange, or NYSE.
Arms Index (TRIN)
The Arms Index, also known as the short-term trading index, compares the number of declining and advancing stocks, or the AD ratio, to the declining and advancing volume, or AD volume.
Why? To gauge the overall market sentiment.
New Highs/New Lows
The New Highs and New Lows indicator, aka the NH-NL indicator, shows the daily difference between the number of stocks that reach 52-week highs and the number of stocks that reach new 52-week lows.
How to Use Technical Indicators
By now you must have some idea of what technical indicators are supposed to be, but you may want to look more into how you can use them.
Identifying Trends
The first and most obvious way to go about using them is to identify trends, and there are a couple of ways you can do that too.
Using trend indicators to confirm market direction
You can use them to more or less confirm where the market is heading, like whether it’s bullish or bearish.
Combining multiple indicators for trend confirmation
Sometimes one indicator may not be enough for 100% accuracy, so you could combine several indicators to have that covered.
Spotting Reversals
At times there will be these significant shifts in prices, which could be noted by just looking for the right things, and by those right things we mean reversals.
Divergence between price and indicator
Sometimes the price and the indicator don’t correspond with one another, like they go in opposite directions, and when that happens, you may have a reversal on your hands.
Overbought and oversold conditions
Take the RSI, for example. When it reaches a low that’s lower than the preceding low but the security’s price hits a low that’s actually higher than the preceding low, then you have a positive reversal on your hands.
Generating Trading Signals
You can generate all sorts of trading signals if you pick the right strategy, some of which we’ll be discussing below.
Crossover strategies
Try to incorporate crossovers in your analysis and look out for bullish and bearish crossovers.
Breakout signals
Breakouts are always a buzz-worthy hit piece if they do happen, considering how uncommon they are, so be on the lookout for those.
Divergence trading
Divergences can be a good way to find out some reversals considering how significant a shift they can be.
Risk Management with Indicators
Risk management is undoubtedly a vital application of keeping it safe when trading with stocks, and below we’ll be looking at some ways of going about it.
Setting stop-loss levels using indicators
One of the most tried-and-tested methods of managing risks is setting up some good stop-loss levels.
Position sizing based on volatility indicators
You could even try adjusting the size of your position based on volatility indicators so that you aren’t as affected when things go haywire.
Combining Multiple Indicators
You can even try blending several indicators together, and depending on what you combine, you can have some interesting results.
The concept of indicator confluence
Multiple indicators can, at times, show similar results, and when that happens, you get even stronger signals, which is always a good thing.
Avoiding information overload
But you don’t want to have too much information, as that could easily result in an overload, which will be counterintuitive.
Creating a balanced indicator strategy
Using this, try your best to then create a balanced indicator strategy, which lays more emphasis on accuracy and can be applicable in various situations.
Common Pitfalls in Using Technical Indicators
Indicators aren’t a one-all-be-all solution, so there will be some pitfalls.
Over-reliance on indicators
You don’t want to over-rely on indicators now too, as that will undoubtedly come to burn you in more ways than one; you have to be able to rely on yourself too as a trader to develop some good skills, which will help you further later on.
Ignoring the broader market context
The market is broader than what can be encompassed in these indicators, as there will be various factors besides price or volume that you’ll need to account for.
Using too many indicators simultaneously
Again, this is bad too, because of the information overload we went over earlier.
Not adjusting indicators for different market conditions
Indicators like your strategies can be adjusted for various market conditions, and you don’t want to ignore that if you care about making the most out of your funds.
Advanced Indicator Techniques
Let’s dive briefly into some advanced indicator techniques now, as there is a lot you could do there too.
Custom indicator development
You could even come up with your own indicator if you feel that the current ones aren’t doing it for you.
Machine learning and AI in indicator analysis
Machine learning and AI are the new buzz now, and you wouldn’t want to miss out on any opportunities in that area.
Intermarket analysis using indicators
Try to analyze as many markets as you can so that you have a more holistic view of things, assuming there is one, of course.
Tools and Software for Technical Analysis
There are all kinds of software and tools you could use in your technical analysis efforts.
Popular charting platforms for indicator analysis
Popular charting platforms like eToro or TradingView can be invaluable for your analysis.
Backtesting indicators
There are even backtesting indicators, such as those offered by TradingView, that can further aid your foolproofing efforts.
Real-time indicator alerts and scanning
Real-time indicators can be a good way to alert you of possible trading opportunities or unfortunate events.
The Future of Technical Indicators
The future of technical indicators is becoming something that’s more interesting, the why of which we’ll be looking at below.
Emerging trends in indicator development
Machine learning is quite the buzz lately, and it’s on a lot of traders’ radars.
The role of big data and AI in refining indicators
AI and big data will undoubtedly automate a lot of the repetition associated with trading, potentially easing things a lot for both the professionals and the newcomers.
Potential challenges and limitations
The problems plaguing current indicators will remain for the most part, like noise or lag.
Conclusion
The enduring relevance of technical indicators
Technical indicators have been the trader’s best friend for so long now, and they’re unlikely to fall in relevance anytime soon.
Balancing indicator analysis with other forms of market analysis
But you shouldn’t rely on indicators too much, and you may want to incorporate other forms of market analysis to better your accuracy.
What are the most popular technical indicators for beginners?
Moving averages, MACD, and the RSI are just some, to name a few.
How often should I update or change the indicators I use?
Only when you realize that their integration has failed to render any meaningful results.
Can technical indicators predict market crashes?
They could, but likely the extent of severity may not fully be grasped.
Are there any indicators specifically designed for cryptocurrency markets?
Since cryptocurrencies are often regarded as securities by many individuals, many existing indicators are applicable, so there really isn’t a need to design one specifically for cryptocurrencies.
How do I choose the right time frame for my indicators?
You choose the right time frame by first finding out what trading style best suits your needs.
