Trading with indicators
Technical indicators are tools used by traders to analyze the movements of the market. They are applied to a market’s chart and use mathematical calculations and formulas to give insight into price movements. They offer an additional dimension to assist in making trading decisions by providing a method of analyzing markets and finding new opportunities.
There are hundreds of technical indicators traders can use, and more are created all the time. They fall into two main categories: trending markets and non-trending markets. Trending market indicators help traders stay on the right side of an asset that is on a bull or bear run. Examples of trending market indicators include moving averages and the MACD. Indicators for non-trending markets can signal when an asset is overbought or oversold in the short term. Examples of non-trending market indicators include the Stochastic Oscillator and the RSI.
While technical indicators take complex calculations and automate them on a chart, traders should be careful when using them. Most indicators are lagging or backwards-facing by their nature, and by the time traders apply their results to a live trade, the opportunity may have passed. Indicators are usually subjective, and two traders may derive completely different conclusions from the same one.
One of the most popular indicators is moving averages (MAs), which smooth out a market’s price movements over a given period to spot general trends. The two most popular types of MAs are simple moving averages (SMAs) and exponential moving averages (EMAs). To calculate a market’s SMA, traders divide the total of its closing prices over a given number of sessions by the number of sessions. Calculating EMAs is a little bit more complicated, as they give more weight to price action that is closer to today’s date.
Traders may consider a market bullish when it is trading above its MA and bearish when it is below. However, traders may also look for other common signals, including buy and sell signals based on the direction of the moving average and moving average crossovers. Crossovers occur when a faster MA crosses a long-term one, and if it crosses from below to above, it is taken as a sign that the market is entering an uptrend. Conversely, if it crosses from above to below, a bear run may be on the cards.
While moving averages form the basis for several other indicators, including MACD, they can be heavily lagging indicators, as they require lots of past price data to function. Traders should be aware that using MAs can give false signals, and they should be used with caution.
Relative Strength Index (RSI) Another popular technical indicator is the relative strength index (RSI), which was developed by J. Welles Wilder Jr. in the late 1970s. The RSI is a momentum oscillator that measures the speed and change of price movements in a market.
The RSI is displayed as an oscillator on a chart, with a range of 0 to 100. Typically, a reading above 70 is considered overbought, while a reading below 30 is considered oversold.
The RSI is calculated using the average gain and loss over a given period, usually 14 days. The formula is quite complex, but in essence, it compares the average gains and losses over this period to determine the market’s strength or weakness.
Traders use the RSI to identify potential trend reversals or confirm existing trends. For example, if a market has been trending upwards and the RSI reaches 70, it may be an indication that the market is overbought and due for a correction. Conversely, if a market has been trending downwards and the RSI drops below 30, it may be an indication that the market is oversold and due for a bounce.
Like all technical indicators, the RSI has its limitations. It can give false signals, especially in volatile markets, and should be used in conjunction with other indicators and analysis to confirm trading decisions.
Conclusion Technical indicators are a popular tool for traders looking to gain extra insight into market movements. They use mathematical formulas and calculations to provide information about a market’s price movements and trend strength.
Moving averages, MACD, and RSI are just a few of the many technical indicators available to traders. While they can be useful, they are not foolproof and should be used with caution. Like any trading tool, they are most effective when used in conjunction with other analysis and trading strategies.
Ultimately, the best way to determine whether technical indicators are right for you is to experiment with them in a demo account and see how they perform in different market conditions. With time and practice, you can learn to interpret the signals they generate and incorporate them into your trading strategy.