21 July 2020
If you are new to trading, you might be wondering how to increase your performance. One of the many ways you can increase your performance is by understanding what indicators are, how they work, and what types of indicators you can use.
Indicators 101: What are Technical Indicators?
A technical indicator is a data analysis tool. It uses prices, volume, and open interest in an asset to analyze the price movement. Indicators help traders understand what the situation of an asset is. With them in place, traders can make better decisions upon price movement.
Technical analysis, on the other hand, evaluates different chart tools. It is a comprehensive analysis of patterns and tools to determine an asset’s strength.
There are 4 basic types of technical indicators.
These indicators measure the direction and strength of a trend. They help traders to work in the same direction as the current trend.
Below are some examples of Trend Indicators.
- Moving Averages: are the calculation of a set of prices over a specific number of days. Technical analysts use them to identify current trends and trend reversals. It allows us to smooth out the price data as well as clarify the direction of the trend.
- Parabolic Stop and Reverse (Parabolic SAR): determines trend direction and trend reversals. It uses a stop and reverse method to identify possible entry and exit points. This indicator is represented by dots in the chart. If the trend is bullish, the dot is placed below the prices. If the trend is bearish, it is placed above the prices.
Oscillator Indicators are also known as Momentum Indicators. Their purpose is to identify the speed of the price movement by comparing prices over time. These indicators move according to price movement until it reaches an extreme level.
Below are some common Oscillator Indicators you can use.
- Stochastics: used to predict price turning points. They do so by comparing the closing price to its range price. It generates overbought and oversold trading signals. They rely on moving averages to reduce sensitivity to market movement. Stochastics indicators consist of two lines. One represents the current value of the oscillator. The other one indicates a simple moving average.
- Relative Strength Index (RSI): is one of the most popular oscillators to use. It measures the stock’s trading strength, the velocity of a change in the trend, and the size of the move. It calculates a ratio between the average gain and the average loss over a given period.
A Volatility Indicator measures the rate of price movement regardless of the direction. Prices can suffer high volatility if they fluctuate up and down fast. Traders use these indicators to study the right moment to buy or sell in a volatile market.
Here are some commonly used Volatility Indicators.
- Bollinger Bands: determines high or low points, according to previous closes. This indicator uses two parameters: period and standard deviation. The parameters are represented by three lines. The space between the two lines will increase according to volatility. The tighter the lines are, the more likely volatility is going to increase.
- Average True Range: this indicator only provides traders with the degree of price volatility. When combined with another indicator, it allows us to measure accurate volatility.
Volume Indicators measure the strength of a trend or confirm a trading direction using the volume. If the volume is high, the prices will keep a high trend, but if the volume were low, the trend will suffer a drop soon.
These are the common Volume Indicators:
- On-balance volume: measures the level of accumulation or distribution. It does so by comparing volume to price movements. If the OBV moves in the same direction as the trend, it is a sign that the trend will remain the same. If the indicator goes against the trend, this means that the trend can be reversed.
- The volume rate of change: shows the direction a trend is taking. It also highlights when the volume will increase.
The tools listed above are incredibly handy for every type of trader. There are many types of indicators that can help you interpret market movements in order to make smarter, more economically efficient trades. Even better, many of these indicators tend to complement each other. But remember to always do your research before making use of indicators, so you can make the best, most informed decisions.