There are four main types of technical indicator that help analysts interpret the stock market. This guide explores them in more detail.
Technical analysts rely on a number of tools when predicting future price trends. Technical indicators are at the epicentre of analysis in the capital markets as they provide valuable information on where the price is likely to go.
I. What Are Technical Indicators?
Technical indicators are mathematical calculations based on price and volume that traders use to carry out technical analysis of the market. Technical analysts rely on these tools to try and interpret as well as predict the market.
Indicators appear as an addition or overlay on trading charts designed to provide insights about price movement. The indicators appear in the shape of candlesticks that traders can use to predict where the price is likely to go.
II. Types of Indicators
There are four main types of indicators in the markets:
- Trend Indicators
- Momentum Indicators
- Volume Indicators
- Volatility Indicators
Trend indicators are a set of indicators designed to show which direction the market is moving, be it up or down. Also known as oscillators, these sets of indicators move between high and low values. Some of the best indicators for following trends include Moving Average Convergence Divergence, Ichimoku Kinko Hyo, and Parabolic SAR.
Momentum Indicators supplement other trend indicators by indicating how strong a trend is in a given direction. These sets of indicators are also useful in picking out tops and bottoms in the market as well as signalling whether a reversal on a prevailing trend is about to happen. Some of the commonly used momentum indicators include Relative Strength Index and Stochastic.
Volume provides information on how many units of a given asset were traded at a given time. By analysing volume, traders can determine how strong a given trend is, be it bullish or bearish.
Volatility indicators provide additional information on how much an asset’s price changes in a given period. By analysing volatility, these indicators can predict how easy it will be to enter and exit a position, depending on volatility levels. Low volatility is an early sign of small price changes, while high volatility indicates fast price changes.
III. How to Use Technical Indicators
Contrary to popular perception, technical indicators are not a trading strategy. Instead, they are underlying tools placed on top of charts to try and identify market conditions. Given the array of indicators available in various trading platforms, the type of indicator deployed depends on the type of strategy a trader intends to build.
Traders looking for long-term moves and large profits might have to focus on a trend following strategy that relies on indicators such as moving averages. Conversely, traders focusing on short term small moves might have to focus their strategy while relying on volatility indicators.
When selecting pairs of indicators, it is important to consider both leading and lagging indicators. Leading indicators such as RSI generate trading signals before market conditions for entering a position occur. Lagging indicators, on the other hand, generate signals when market conditions have already appeared and are thus used to confirm leading indicators, making it possible to avoid trading false signals.
Sources & references
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