Friday, May 24, 2024

Technical Indicator

A Technical Indicator is a mathematical calculation that can be applied to price and volume data. It can even be applied to other technical indicators.

The result is a value used to predict future price changes.

Technical indicators are wavy lines above, below and above price information on a chart.

They are used by Forex traders who follow technical analysis.

Technical indicators provide different perspectives from which one can analyze the strength and direction of underlying price movements.

By analyzing historical data, technical analysts use indicators to predict future price movements

Technical indicators can play three roles:

  1. reminds traders to meet certain conditions.
  2. Predictsprice direction.
  3. Confirm Analysis of current price trends or other technical indicator recommendations.

Two major categories of technical indicators

Technical indicators are divided into two categories:

  1. The Leading indicator gives trading signals that a trend is about to begin
  2. The Lagging indicator follows price action.

Leading Indicators attempt to predict prices and thus guide price movements by using shorter periods of time in their calculations. The most popular leading indicators are MACD, RSI, and Stochastic.

These indicators typically work by measuring how “overbought” or “oversold” an asset is. Our hypothesis is that when something is “oversold,” it will bounce back.

Lagging indicators signal after a trend or reversal has begun. The most common lagging indicator is the moving average.

They don’t warn you about upcoming price changes, they just tell you what the price is doing (either up or down) so you can trade accordingly.

Lagging indicators cause you to delay buying and selling, but at the cost of missing out on early opportunities, they can keep you on the right side of the market, greatly reducing your risk.

The general approach is that you should use lagging indicators in trending markets and leading indicators in sideways markets.

Chart layout of technical indicators

Regarding the position of technical indicators on the chart, technical indicators are divided into two categories:

  1. Overlay : Technical indicators are plotted on top of the price on the chart using the same scale as the price. Examples include moving averages and Bollinger Bands.
  2. Oscillator : A technical indicator that oscillates between local minima and maxima is plotted above or below on the price chart. Examples include MACD, RSI, and Stochastic.

Four technical indicators

There are four types of technical indicators:

  1. Trend Tracking
  2. Power
  3. Volatility
  4. Volume

Trend Following Indicators

Trend following indicators help traders trade currency pairs that are trending up or down.

These indicators can help point out the direction of a trend and can tell us if a trend is indeed present.

Trend following indicators use some form of price averaging to measure the direction and strength of a trend.

When the price is above the average, it is considered to be in a bullish trend. When prices are below average, it indicates a bearish trend.

Here are examples of trend following indicators:

  • Moving Averages are used to identify current trends as well as support and resistance levels.
  • MACD is used to reveal changes in the strength, direction, momentum and duration of a trend.
  • The Parabolic SAR is used to spot potential reversals in price direction.

Momentum Indicator

The momentum indicator helps determine the speed of price movement by comparing prices over a period of time. It can also be used to analyze volume.

Calculated by comparing the current closing price to the previous closing price.

Typically this appears as a line below the price chart that fluctuates as momentum changes.

When divergence occurs between price and a momentum indicator, it can signal a change in future price direction.

Here is an example of a momentum indicator:

  • Random Shows the position of the closing price relative to the high and low range for a certain number of periods.
  • CCI is an oscillator that helps identify cyclical shifts or trend reversals.
  • RSI measures the strength of a currency pair by comparing its upward movement to its downward movement over a given time period.

Volatility Indicator

The volatility indicator measures the rate of price movement, regardless of direction.

This is usually based on changes in the highest and lowest historical prices.

They provide useful information about the range of buying and selling that occurs in a particular market and help traders identify the points at which direction may change.

Here are examples of volatility indicators:

  • Bollinger Bands Help determine whether relative prices are high or low
  • Average True RangeA measure of volatility that takes into account any gaps in price movements.
  • Standard deviation is a statistical indicator of market volatility, measuring the dispersion of prices from the average price.

Volume indicator

Volume indicators measure the strength of a trend or confirm the direction of a trade through some form of averaged (or smoothed) volume.

The strongest trends tend to occur when volume increases.

Here is an example of a volume indicator:

  • Chaikin Money Flow (CMF) Measures the volume-weighted average of accumulation and distribution over a specified period. The principle behind Chaikin Money Flow is that the closer the closing price is to the high, the more money will accumulate.
  • On-Balance Volume (OBV) Measures buying and selling pressure as a cumulative indicator, increasing volume on up days and decreasing volume on down days.
  • The Volume Oscillator (VO) displays the difference between two moving averages of a security’s volume as a percentage. It works on the premise that t is not the actual volume level, but the change in volume relative to recent volume, which is more technical.

How to Minimize False Signals

No technical indicator is foolproof.

To minimize false signals (price moves differently than the indicator expected), technical indicators are often combined with other “tests” or other indicators to increase their reliability.

This is called waiting for the “confirmation” of a signal generated by a technical indicator.

Additional testing is called “Filter“.

The most common filters fall into the following categories:

  • Time : The signal must exist for the specified time. For example, the 50-day moving average must be above the 200-day moving average for at least 3 trading days.
  • Amplitude: The signal must be within the specified range. For example, the oscillator must be greater than 80% or less than 20%.
  • Volume : Indicators based on higher volumes are generally more significant.

Certain indicators work better on specific time frames , so it makes sense to choose an indicator that fits your trading range.

The frequency of a

trading signal is another factor to consider.

If you are a day trader, you will want an indicator that can generate many trading signals in a day. Swing traders need fewer signals.

Using indicators in conjunction with price action analysis often results in fewer signals and lower trading costs.

Always remember, technical indicators are…Indicators.

They do not guarantee that the price will move in a certain way.

With technical analysis, you often cannot tell whether this is a true trend reversal or a false trend reversal.

This is why it is recommended to look at charts with multiple time frames to add context to your views.

If you want to learn more foreign exchange trading knowledge, please click: Trading Education.

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