What is a Technical Indicator
Technical Indicators are a result of mathematical calculations/algorithms designed by professional traders and are based on indications of price or volume.
The values obtained are used to create various patterns that may be added to a chart and allow traders to forecast probable price changes and, therefore, probable times at which to open a buy or sell position in addition to when they should close current open positions.
There are many technical indicators; however, here are the most common types:
Support and Resistance
- When the market moves in a specific direction and then pivots and changes direction, the highest point that was reached before the market changed direction is called the Resistance Level. In the same way, the lowest level the market reaches before the market pivots is called the Support Level.
- It is important to note that if the market passes through a resistance level, then that resistance level can also become a new support level. The same applies in the opposite direction. Previous resistance and support levels are also used as an indicator for future pivots and therefore possible entry points into the market.
- Moving Averages show the average price within a defined time period by considering the most recent closing prices over the given time period and the result is then divided by the number of prices used in the calculation:
For example: In a 10-day moving average, the last 10 closing prices are added together and then divided by 10
- There are four types of Moving Averages: Simple MA, Exponential MA, Smoothed MA, and Weighted MA. They differ from each other only in terms of the weight coefficients that are assigned to the latest data
- Moving averages are used to define areas of support and resistance, entry points into the market, to emphasize the direction of a trend, and to smooth out price and volume fluctuations
- The direction of the indicator shows whether a bullish or bearish trend is present in the market at the moment
- With two or more moving averages applied to one chart, the further apart they are from one another the stronger the indication of the current trend
- When the moving averages intersect, this confirms the change in a trend. It is only a confirmation because the change of this indicator is late in comparison with a price change
- Oscillators are designed to indicate a possible change in the trend of a specific trading instrument by showing whether the instrument is either overbought or oversold, therefore allowing traders to determine when a change in the current overall trend will occur and in turn, an entry point into the market.
- The RSI indicator is used to determine the state of the market – whether it is overbought, oversold, or stable. If the RSI tops out in the upper zone [overbought (sell signal), > 70] and then returns to the middle zone, the price would move in the same direction. If the RSI bottoms out in the lower zone [oversold (buy signal), < 30] and then returns to the middle zone, the price would move in the same direction. In other words, the price and the RSI movement correlate.
- The Stochastic oscillator is used on the trending markets. If both lines top out in the upper zone [above 80% mark (sell signal)] and then the indicator returns to the middle zone, the rate would move in the same direction. If both lines bottom out in the lower zone [below 20% mark (buy signal)] and then the indicator returns to the middle zone, the rate would move in the same direction.
- Trading instruments usually retrace the previous day’s trades. The most popular retracement is the Fibonacci Retracement indicator which is a chart tool used to determine the support and resistance levels of an instrument
- The Fibonacci Retracement levels are created by drawing a trend line between two extreme points and then splitting the vertical distance according to the specified percentages
- The Fibonacci Retracement can include up to 13 lines. In order to find these retracement levels, you need to identify the recent Swing Highs and Swing Lows (extreme changes in the trend direction)