5 important Indicators Used in Technical Analysis
There are several tools used by professional, intermediate, and rookie traders to form a technical trader's strategy. These strategies are paramount to a trader's success and aren't a one fits all type of tool. Trading indicators are a great tool usually paired with specific risk management tools to help traders gain more insight into price trends.
These price trends both on positions and broad averages and the type of opportunities that are discovered on your nightly research are all affected by these trading indicators. So what are trading indicators?
Definition of Trading Indicators
Trading indicators are mathematical calculations plotted on a price chart as lines that aid trades in identifying specific trends and signals within the market.
They are used in a variety of markets i.e commodities trading, forex trading, and share trading to predict future trends(Leading indicators) and offer a historical report on background conditions(lagging indicators).
Categories of Trading Indicators
There are five(5) major categories of technical trading indicators:
• Trend indicators (lagging)
• Momentum (leading)
• Mean reversion (lagging)
• Relative strength (leading)
• Volume (lagging or leading)
5 Important Technical Trading Indicators
Here are five(5) important trading indicators used by traders to predict market trends:
Relative Strength Index(RSI)
The relative strength index is a popular and widely used indicator in technical analysis, falling under the oscillator category. It is used to help traders to find momentum, divergence, and hidden divergence signals and oversold and overbought market conditions in a financial market.
An oversold signal is a suggestion that in a specific market, short term declines may be reaching a maturing point. While an overbought signal is a suggestion that the short term gains in a market may be reaching maturity. A divergence signal is described as a situation whereby the lows and highs of the market price are moving in different directions to the lows and highs on the RSI indicator.
Since the Relative Strength Index is a rangebound indicator, it is best to use it with prices that are rangebound as well. In trending markets, it is often best practice to utilize RSI signals against the trend for exist and in alignment with the trend for entry in trading both long and short signals.
Moving Average Convergence/Divergence (MACD)
The moving average convergence/divergence trading indicator targets fluctuations in a share price's momentum. It receives and collates data from differing moving averages to aid traders in identifying potential opportunities around resistance and support levels.
The divergence indicator signals that the averages are moving away from each other, while, the convergence indicator signals that the averages are coming together.
There are three components of MACD; the histogram, MACD line, and the signal line
• Histogram: this is a graphical representation of the distance between the signal line and the MACD line
• MACD line: this line works at measuring the difference between two moving averages
• Signal line: the signal line is used in the identification of changes in price momentum also acting as a trigger for selling and buying signals
MACD is widely used due to its reliability and simplicity. Its ability to determine both the turning point of a trend and its buy and sell signal is a major positive for this indicator.
The Bollinger Bands technical analysis tools are a type of trading band that presents a framework used for determining on a relative basis how high or low prices are. Bollinger Bands are based on the first principles of the market used for several processes like; creating an individualized analytical approach, aiding of recognition of pattern, construction of rigorous trading systems for the financial markets, etc.
BB are curves that are drawn in and around the price structure, which consists of an upper band lower band, and a moving average. These parameters are utilized to ascertain if prices are low or high on a relative basis. BB is a tool that best serves you when the middle band is used to reflect the trend of the intermediate trend. This is so the relative price level information is combined effectively with the trend information.
The stochastic oscillator developed in the 1950s by George C. Lane is a momentum indicator used to compare a particular closing price of an asset to its high-low range over a certain number of periods. It is a range-bound oscillator with a premise that momentum precedes the price, therefore, them stochastic indicator can signal the precise movement right before it occurs. It is a technical analysis indicator that gives room for massive versatility in trading.
A very important factor of Stochastic RSI is the stochastic divergence. It has two main types namely;
• The bullish divergence: This occurs when the market price is making a lower low, while, the stochastic is making a higher low
• The bearish divergence: It occurs when the market price is making a higher high, but the stochastic is making a lower high
Other activities the stochastic indicator can be used for include; buy/sell confirmation, scalping, day trading.
MA is used as a simple technical analysis tool in trading by customizing the average price to determine price data. The greatest advantage of using MA as a technical indicator is its different types that cater to several forms of information i.e to support an uptrend, the moving average acts as a base ground, while it acts as a 'ceiling' in downward trends.
There is a whole host of other indicators to consider including average true range (ATR), On-balance volume (OBV), average directional movement index (ADMI). But these are the five vital indicators that you should ensure to study if you want to make a successful career out of trading. Make sure to acquire In-depth knowledge on each indicator you choose to use and remember to never invest money you can't afford to lose in the market. Happy investing!
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