Introduction to technical indicators

What is a technical indicator?

In stock market analysis, a technical indicator is nothing but a tool that provides an indication about the condition or direction of the economy. Indicators take the form of calculations based on the price and the volume of a security and measures factors such as volatility and momentum. They are also used as a basis for trading as they can form buy-and-sell signals. Indicators provide an extremely useful source of additional information.

Technical analysis is broken into two main categories:-

  1. Chart patterns (discussed in technical analysis part 1)
  2. Indicators and oscillators  ( discussed below)

What does it offer?

Some technical indicators, such as moving averages are derived from simple formulas and the mechanics are relatively easy to understand. Others, such as stochastic, have complex formulas and require more study to fully understand and appreciate. Regardless of the complexity of the formula, technical indicators can provide unique perspective on the strength and direction of the underlying price action.

Types of indicators:

There are basically two types of indicators based on what they show users:

  1. Leading indicators
  2. Lagging indicators.

Leading indicators, as their name implies, are designed to ‘lead’ price movements. That is-the indicators move first and price action follows. Some of the more popular leading indicators are commodity channel index, Momentum, relative strength index, stochastic oscillators and Williams %R.

The advantage of using leading indicators is that the signals act as warning against a potential strength or weakness. Leading indicators are more ‘sensitive’ to price fluctuations.

Lagging indicators as their name implies, follow the price action and are commonly referred to as trend-following indicators. It has less predictive qualities. The usefulness of lagging indicators tends to be lower during non-trending periods but highly useful during trending periods. This is due to the fact that lagging indicators tend to focus more on the ‘trend’ and produce fewer buy-and-sell signals. This allows the trader to capture more of the trend instead of being forced out of their position based on the volatile or sensitive nature of the leading indicators. Moving averages and Bollinger bands are examples of lagging indicators.

Where to find these indicators?

Most of the common indicators and oscillators are available readily on your online trading platform screen.

Know it:

  • Always remember- Technical Indicators are sources of additional information.
  • The purpose of indicators is to ‘indicate’. This may sound very straightforward, but sometimes investors ignore the price action of a security and focus solely on an indicator. Indicators filter price action with formulas. As such, they are derivatives and not direct reflections of the price action. This should be taken into consideration when applying analysis. Any analysis of an indicator should be taken with the price action in mind. What is the indicator saying about the price action of a security? Is the price action getting stronger? Weaker?
  • Indicators should be studied in context of other technical analysis tools. An indicator may show a buy signal but the chart pattern and fundamentals may be weak.
  • There are two types of indicators – leading (one that leads the price change) and lagging indicators(one that follows the price action)

You may like these posts:

  1. Technical Analysis
  2. A study of chart patterns
  3. Importance of Volume in Technical Analysis

1 Response to “Introduction to technical indicators”

Woods

November 3, 2011 at 8:45 pm

Wow! Great thininkg! JK

Leave a Comment