Why Are Technical Analysis Indicators Useful for Traders? Vol.1

Why Are Technical Analysis Indicators Useful for Traders? Vol.1

Having a technical approach can be significant in forming your trading style. As there are various ways of analyzing market information through technical indicators and the variations and combinations of features are endless, understanding how to go through all that data and analyze it is vital for you as a trader.

To put it simply, Technical Analysis is the study of data generated from the market and the actions of the people in the market. It is based on observing and analyzing chart patterns and indicators. Learning how to examine charts, graphs, and gauges are essential for identifying potential trading opportunities and future trends.

technical analysis

Indicators essentially represent calculations based on the price and volume of a commodity or security and they measure money flow, trends, volatility, and momentum or more generally supply and demand. Indicators can be divided into two main categories – leading and lagging.

  • A leading indicator moves ahead of the price change and is used to forecast the next price movement.
  • A lagging indicator follows the price change and is used to confirm the data from the leading indicators.

Indicators can also be categorized into Oscillators and Non-bounded indicators, based on the way they are built. An oscillator generates a number which shows a value that varies between two points, between a range or above/below a line. They primarily oscillate between oversold (0) and overbought (100). Non-bounded indicators do not use a set range to analyze trends.

Average directional movement index (ADX)

The average directional index is a measure used to determine the average strength of a trend over time. It is a lagging indicator, as it analyzes events which have already occurred. The ADX along with the Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI) form a Directional Movement System developed by Welles Wilder. Directional movement is determined by comparing the difference between two consecutive lows with the difference between their respective highs and so it defines both the strength and direction (either upwards or downwards) of a trend.

Aroon indicator

The Aroon indicator is designed to identify strength, changes in the direction of trends and the possibility of a new trend. It is a set of two separate measures (Aroon Up and Aroon Down), each bound in a range between 0-100 to define a security’s strength or weakness. The indicator measures the number of periods since the price has been registered x-period (usually the value is in days) high or low. The closer the value is to 100, the stronger the trend. The first sign that a new trend is about to begins when the Aroon-up line crosses and goes above the Aroon-down line.

Bollinger bands

The Bollinger bands are a trademarked statistical chart measuring a financial instrument’s or a market’s price and volatility over time. It consists of a moving average acting like a center line and two price bands above and below it. Those price bands represent standard deviations from the mean value, which is the moving average in this particular case. They indicate price volatility, and so they change as volatility increases or decreases. When there’s low volatility (or relatively stable price), there is little standard deviation indicating data close to the mean and so the bands contract. When the market’s volatility rises, the standard deviation becomes higher, and its data is spread over a broader range of values; hence the bands widen.

Moving average

The Moving Average is an indicator that is most commonly described as smoothing or flattening price fluctuations and filtering the noise. This way it highlights major and long-term trends. It is lagging, trend following indicator which means that it is based on past events in the market and define the current trend, its direction (either up or down) or possible reversal, but with a lag. It also helps to recognize flat market trends. The line that is formed by the moving average represents the average price over a period, which is a median value, calculated by averaging a set of passed data points from several consecutive time periods. The value set keeps changing as new data is continually added, and old information is being skipped.

There are three types of Moving Averages: Simple Moving Average, Exponential Moving Average, and Weighted Moving Average.

  • Simple Moving average. It is called “simple” as it represents an arithmetic mean – the average of a set of values. It calculates the average price of an asset over a defined period or a fixed number of periods.
  • The Exponential Moving Average reduces the lag and data delay as it is applying more weight to the more recent prices. The rate of decrease between one price and its preceding price is not fixed, but exponential. It calculates the average between all the price entries up to now, without skipping values, when new values are entered. The most popular short-term averages which are often used are the 12 and 26-day exponential moving average.
  • The weighted moving average uses multiplying factors to give different weights to data at different positions. It focuses on the most recent prices and the decrease and difference between one price, and the preceding one is a constant number, usually equals 1.

To be continued in vol.2