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Technical indicators are the basis of technical
analysis. There are dozens of technical indicators, how to choose good stock
indicators? Technical indicators are used to know when to enter or exit a trade.
If you know how to enter and exit a trade, you can easily make profits. That is
why choosing good stock indicators are important.
Some of stock indicators are more common and useful than others. Also you need a few of them to know when to enter or exit a trade not all off them.
Technical indicators can be divided into four major categorizes:
1- Price Indicators: Oscillators, Bollinger Bands
3- Number Theories: Fibonacci numbers, Gann numbers
4- Waves: Elliott's wave theory
Price Indicators are computed by prices data. A subcategory of Price Indicators are oscillators. Oscillators are indicators that are usually computed from prices and tend to cycle or “oscillate” within a fixed or limited range.
Common oscillators are: Momentum and Rate of Change (ROC), Moving Average Convergence/Divergence (MACD), Relative Strength Index (RSI), and Stochastic Oscillator.
Momentum and Rate of Change (ROC)
Momentum is an oscillator designed to measure the
rate of price change, not the actual price level. This oscillator consists of
the net difference between the current closing price and the oldest closing
price from predetermined period.
The formula is:
Momentum (M) = CCP – OCP
Where: CCP is Current Closing Price and OCP is Old Closing Price
Momentum is simply the difference, and the ROC is a ratio expressed in percentage. Momentum and Rate of Change (ROC) are simple indicators showing the difference between today's price and the close N days ago. Momentum in general term means strongly movement of prices in a given direction.
Moving Average Convergence/Divergence (MACD)
MACD is computed by subtracting a longer moving average from a shorter moving average. MACD is used with a signal or trigger line, which is a moving average of MACD. If MACD and trigger line cross, then this indicate that a change in the trend is likely. MACD developed by Gerald Appel.
The MACD smoothes data, as does a moving average; but it also removes some of the trend, highlighting cycles and sometimes moving in coincidence with the market .
Relative Strength Index (RSI)
RSI measures the relative changes between up-moves or down-moves and scales its output to a fixed range, 0 to 100. RSI is an oscillator and Welles Wilder devised it.
The formula for calculating RSI is:
RSI = 100 – [100/ (1+RS)]
Where: RS is average of N days up closes, divided by average of N days down closes and N is predetermined number of days that usually chosen 14.
RSI can use as an overbought/oversold indicator. A buy signal is when the RSI moves below a threshold, into oversold territory, and then crosses back above that threshold, usually 30 is taken for oversold threshold. A sell is signaled when the RSI moves above another threshold, into overbought territory, and then crosses below that threshold, usually 70 is taken for overbought threshold.
Technical Indicators - part 2
In this page you will be familiar with two
indicators: an oscillator that is Stochastic Oscillator and Bollinger Bands
As I mentioned before, Oscillators are technical indicators that tend to cycle or “oscillate” within a fixed or limited range, and Momentum in general term means strongly movement of prices in a given direction.
The Stochastic Oscillator is a momentum indicator, it indicates whether the market is moving to new highs or new lows or is just meandering in the middle. This indicator is based on George Lane 's observations.
The Stochastic Oscillator is plotted in two lines Fast %k and Fast %D.
The formula is:
Fast %k = 100 * [( C – L (n) ) / ( H (n) – L (n) )]
C is the most recent closing price.
L (n) is the low of n previous trading day (or bar).
H (n) is the high price of the same n previous day (or bar).
Usually n is chosen 14.
A 3-period (day or bar) moving average is taken from Fast %k and called Fast %D. Fast %D is used as a signal line in the same way that the moving average of the MACD is used as a signal line for the MACD.
Stochastic Oscillator is plotted in two lines but, usually these lines cross each other many times. Now to smooth the chart, a 3-period moving average is taken from Fast %D and called Slow %D (Also, Fast %D is called Slow %K), so the smoothed chart is plotted with Slow %K and Slow %D.
Using of Stochastic Oscillator
1- Oscillators are used as an overbought/oversold indicator. A buy is signaled when the oscillator moves below 20, and then crosses back above 20. A sell is signaled when the oscillator moves above 80, and then crosses below 80.
2- Also, when %K crosses above or below %D, Buy and sell signals can be given. But, may be crossover occurs frequently in short periods and causes bad results. This using isn't very common.
John Bollinger created Bollinger Bands in the 1960s; Bollinger Bands are used to determine support and resistance levels. This indicator consists of three lines; the middle line is an exponential moving average of price data and the two outside bands are equal to the moving average plus or minus standard deviation.
Standard Deviation is a statistical measure that indicates volatility of price. The bands will expand when price becomes volatile and they will contract during less volatile periods.
Using of Bollinger Bands
1- Bollinger Bands are used to determine the boundaries of market movements. If a market moved to the upper band or lower band, then there was a good chance that the market would move back to its average. In the other words, when price closes to upper band, market is overbought and when price closes to lower band, market is oversold.
2- Another using of Bollinger bands is that to indicate up-trends and down-trends. If price deflects off the lower band and crosses above moving average then price fluctuate between upper band and moving average, it comes to indicate upper price target. It is visa versa to indicate lower price.