Indicators are the cornerstones of technical analysis and play an important role in giving and confirming entry and exit signals in stock trading systems. There are quite a number of different types of indicators but they all fall into two categories:
Leading indicators are usually considered better than lagging indicators as they probable direction before they occur; however, their predictive nature does not necessarily increase their accuracy or validity.
Indicators also measure different aspects of the market action regardless of whether they are lagging and leading indicators. In addition, depending on how they are calculated, indicators can oscillate above and below a zero line. These are called oscillating indicators. Other types of indicators can be trend indicators, momentum indicators, volatility indicators, market strength indicators and cycle indicators. Different types of indicators can often contradict each other as some are better suited to trending markets while others are better suited to non-trending or ranging markets.
It is important that you understand an indicator, what it measures, how it is calculated, and how it reacts to price changes, before you use it. Once you know how an indicator works, and how it reacts to price changes, you would be better equipped at trading the technicals.
Oscillators are indicators that technicians use to analyze securities or equities that are not trending but trading in a range. Thus, oscillators are most beneficial when a security is in a horizontal trading pattern. Oscillators move higher and lower between extreme reading that determine overbought or oversold conditions. These overbought or oversold conditions indicate probable turning points in price movement and can be used as potential entry or exit points.
Popular oscillating indicators include the Stochastic Oscillator, RSI, CCI, and Williams %R. ...
Relative Volatility Index
Volatility indicators, which measure the volatility of a security's price action, are important to day traders. When volatility increases, the price movements are more volatile and traders can gain more money in a short period of time. Some of the popular volatility indicators include J Wells Wilder's Average True Range, John Bollinger's Bollinger Bands, Chaikin's Volatility, and Relative Volatility Index (RVI).
The Chicago Board Options Exchange (CBOE) also provides a some volatility indicators, such as the S&P 500 Volatility Index (VIX), the S&P 100 Volatility ...
A Trend Indicator (MACD)
The main purpose of a trend indicator is to identify the existence and direction of a trend. These indicators accomplish this by smoothing the price action of a security and tend to be lagging indicators as they are based on past price action. Thus, they tend to follow price action and are sometimes referred to as trend following indicators.
By far the most common trend indicator is the moving average (MA). Other trend indicators include Average Directional Index (ADX), Parabolic SAR, Price Oscillator, Zig Zag and Trend Lines. How the trend is determined ...
The market strength can refer to the broader market as in an All Share Index, or it can refer to the probable strength of a particular trend of a given stock or commodity. When it is used to refer to the broader market index, the number of advancing and declining stocks in a market are taken into consideration. When it is used to refer to a particular stock or commodity, volume or open interest is taken into consideration.
The popular Market Strength indicators for individual stocks and commodities include On Balance Volume (OBV), Accumulation/Distribution, ...
A Momentum Indicator
Momentum indicators can be used to track the rate at which the price of the underlying security changes rather than the price changes itself. These indicators are usually leading indicators as they tend to be oscillators by nature.
Some momentum indicators, such as the Stochastic Oscillator and the Relative Strength Index (RSI), have an upper boundary (usually 100) and a lower boundary (usually -100) while others, such as the Commodity Channel Index and the MACD, do not have upper and lower boundaries. In the case of the latter, historical high and low levels ...
Commodity Channel Index
Cycle indicators are base on the theory which suggests that stock market have a tendency to move in cyclical patterns from periods of bullishness to periods of bearishness and back to periods of bullishness. These cycles are repeated with a regularity that allows them to be used to anticipate price changes at key cyclical intervals. However, shorter cycles are present in shorter time frames with smaller cycles operating within larger cycles.
It is this phenomenon that makes cycle analysis difficult as at any moment a shorter cycle ...
What is Technical Analysis?
In its simplest sense, technical analysis makes use of stock charts to study the past movement of prices in an attempt to anticipate the probable future movement of that security's price. In other words, technical analysis uses a security's historical price, namely its open, close, high and low prices, as well as its volume data to construct stock chart to determine which direction the security should take, based on its past data.
Some forms of technical analysis augment the price chart by constructing technical indicators and oscillators that are based on the security's past price data. These indicators and oscillators are interpreted and used to develop trading systems. Other forms of technical analysis are based on identifying archetypical chart patterns, such as the head and shoulders (H&S) pattern and double top reversal patterns, that reoccur repeatedly as the chart develops.
Elliott Wave Theory
Ralph Elliott was a qualified accountant who discovered the underlying wave pattern, know today as the Elliott Wave Principle that belies the price movement in the stock markets, the commodities markets and the forex markets.
In Elliott Wave Theory, the market price traces a fairly rigid, cyclic pattern that is constituted by an impulse phase that consists of a five wave structure and a corrective phase that consists of a three wave structure. A five wave impulsive phase and a three wave corrective phase forms a complete cycle. The identification of the correct ...
Welles Wilder's RSI
J. Welles Wilder, Jr., developed a keen interest in the stock markets in the 1970. Approaching the stock market from an engineering perspective, Wilder set about trying to identify mathematical models that could be used profitably to trade what appeared to be random price movements.
Wilder's studies let him to discover a number of mathematical models on which much of modern day technical analysis is based. These mathematical models included technical indicators such as the RSI, Parabolic SAR, and DMI, which have become some of the most widely used ...