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What Are Technical Indicators?

We’ve previously covered trading for a living and had quite a lot of interest in the subject of market analysis, which broadly speaking falls into two distinct areas, fundamental analysis which focuses on an understanding of the business and the wider market, and technical analysis which uses historic performance to project future prices. While the former is well out with the scope of a single college course the latter depends only on an understanding of the principles behind technical indicators, these can be broken down into two broad categories: trend following indicators and oscillators.

What Are Technical Indicators?

 

20120905 - investing in the stock marketIn reality, traders can use a technical indicator as a tool for market analysis applicable across currency speculation and stock trading alike. After all, what these tools are used for is to chart prices and volumes. With this data a curve can then be drawn which allows one to visualize information about the market.

Nonetheless. there is something that is crucial to keep in mind when using a set of indicators, which is that both oscillators and trend following indicators have their strengths and weaknesses. As such, it is a good idea to use both indicators in conjunction.

The different types of oscillators include the stochastic oscillator, the Relative Strength Index, and the Force Index. Different tendency following indicators include the moving average and the MACD (moving average convergence divergence).

As the name quite rightly applies, trend following indicators are the technical indicators that work best during periods in which long established trends appear to be prevalent. They highlight the fact that a previously established trend that is predictable in running its course, and that it’s a good time to jump in and let the current pull you along. What you’re dealing with here is inertia, in which changes tend to be hidden and offset by other factors. These indicators are good because they allow you to see clearly where a price is headed more or less, and they help you determine both when price and value coincide, and when they differ wildly. On the downside, however, if there is a drastic and unexpected change, you will be slow to respond if you are relying solely on trend following indicators.

In contrast. the oscillators are “nervous” indicators that are constantly passing wildly from one side to another as they cross a line of reference. These are the first indicators that detect changes in trends and turning points for prices. Their weakness is that due to their erratic character there are a lot of false alarms which appear to suggest that buying or selling is a good idea, when in reality neither action is advisable.

Two particular oscillators that are of interest are the stochastic and the force index. The former helps us to visually determine overbought and oversold conditions. The later is much more sensitive, and gives us precise signals as to when to really get in deep when the market is euphoric. Moreover, it’s ideal for determining divergence.

An ideal combination of technical indicators would be a trend following indicator together with an oscillator. Of course, you can include more than one indicator of each type, even though it’s always best to keep it simple; when there’s too many indicators it can be difficult to make sense of a glut of information.

So what are technical indicators? All technical indicators are mathematical formulas with coefficients, and the value of these coefficients can vary. With the more robust indicators, such as MACD, variation in the parameters does not drastically alter the character of the indicator, and it will continue to give the same results more or less. Then there are other indicators (the Relative Strength Indicator or RSI for example) where varying a coefficient really does make a difference.

In short, it’s best to use an oscillator in order to readily detect abrupt changes and react immediately accordingly. A trend following indicator lets you know when things have leveled off and it’s time to get out.

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AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

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