Technical Indicator Definition
Technical indicators refer to technical analysis tools used by investors to make investment decisions based on future price movements derived primarily from historical prices. Influenced by the signals produced by the indicators, investors determine the entry and exit points.
Investors always prioritize using indicators to time their investments and make the most profitable decisions. Indicators range from simple to complex ones, and their incorrect usage can lead to losses. Hence, almost every user studies indicators before investing; even amateur traders use simple indicators to trade.
Table of contents
- Technical Indicator Definition
- Technical indicators refer to techniques used by entities during technical analysis to make investment decisions. It largely uses previous prices to forecast future price changes.
- Its application generates buy or sell signals, and traders decide entry and exit points based on the signals generated.
- The basic types are overlays and oscillators. Examples are On-Balance-Volume (OBV), Moving Average Convergence Divergence (MACD), and Average Direction indicator (ADX).
- Traders use a combination of various indicators to reach a plausible conclusion.
Technical Indicator Explained
Technical indicators are widely used in financial markets to analyze and predict price movements based on previous price movements. It is the core of many trading methods. A trading system is strengthened by applying indicators or pattern-based methodologies that provide buy/sell signals for trading. Combining different indicators can form a single trading rule and the trading system.
Technical indicators in stock tradingStock TradingStock trading refers to buying and selling shares of an entity listed on a stock exchange. are an important element that assists the investment decision-making process. Its application is unavoidable in creating profitable and successful short-term and long-term trading strategies. At the same time, any calculation error in indicators may lead to wrong decisions and result in financial losses. Moreover, it is more apt for stock trading than other streams like forex trading and crypto trading. If the indicator selected is not apt, it can deliver the wrong signals.
Indicators in stock trading use the stock movement chart as the prime input element. Indicator development is not limited to the use of objective mathematical models; it can also include subjective variables. It aids in expressing the decision-making logic in a more “human” way. Such an indicator takes broad market information as additional input, such as profitability and volatility of stock prices, and produces signals.
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Types of Technical Indicators
There are different types of classifications of indicators. The basic types are oscillators and overlays. Another important classification is segregating the technical indicators into momentum, trend, volume, and volatility indicator classes. Furthermore, it is also classified as lagging indicators and leading indicators. Lagging indicators are usually employed to measure trends, whereas leading indicators are typically used to detect overboughtOverboughtOverbought refers to market scenarios where stock is traded considerably higher than its fair value. or oversold conditions.
Oscillators focus on the market momentum and shift. It is called oscillators because it presents a trend indicator oscillating within the bounds of higher and lower bands. Oscillators point to overbought and oversold conditions. Most of the data comes from charts, and traders often apply multiple oscillators on one chart to get clarity. Relative Strength Index (RSI), Commodity Channel Index (CCI), Moving Average Convergence Divergence (MACD) and Awesome Oscillator (AO) are some of the examples.
Overlays are formed over the main or source price chart. The name signifies that they are represented on the reference price chart itself. Support, Resistance, Trendline, Moving average, Channel, and Bollinger Bands are common overlays.
List of Technical Indicators (Most Common)
The apt indicators to use varies with various factors like asset classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples., goals, and strategies followed by the investors. For example, popular technical indicators for day-trading are Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Average Directional Index, On-Balance-Volume, etc. At the same time, popular technical indicators for swing trading are Moving Average, Volume, Bollinger Band, Stochastic, etc.
On-Balance VolumeOn-Balance VolumeThe On-Balance Volume (OBV) is a technical indicator that reflects the buying or selling pressure of a stock. focus on trading volume to predict price movements. OBV value fluctuates based on the trading volume. An increasing OBV indicates buyers’ behavior toward the market entry, positive volume pressure, and upward price movement. Conversely, a declining On-Balance-Volume showcases lower prices.
Moving Average Convergence Divergence (MACD)
Moving Average Convergence Divergence (MACD) uses two moving averages. If the two averages are meeting or converging, the scenario is considered convergence, and the momentum decreases. Whereas if the averages are diverging, the scenario is divergence, and the momentum increases. The strategy starts with creating a MACD line and the signal line. If the MACD crosses and moves above the signal line, it is usually a buy signal, and if the MACD crosses below the signal line, it is a sell or short signal.
Average Direction Indicator (ADX)
The technical analyst, Welles Wilder, developed the ADX representing the strength of a price trend. ADX value moves from 0 to 100. A reading below 20 indicates a weak trend, between 20 to 40 indicates a strong trend, and above 40 indicates an extreme trend. When the ADX line is rising, the strength also increases, and the price is expected to move in the direction of the trend. Whereas, if the ADX falls, the strength decreases and may cause a shift in the primary trend.
Frequently Asked Questions (FAQs)
Technical indicators refer to techniques used by investors to make investment decisions with the help of buy or sell signals. It largely uses previous prices to forecast future price changes, and investors decide entry and exit points based on the signals generated.
There are various classifications of indicators. Oscillators and overlays are the basic types. Segregating the indicators into classes like trend (Example: ADX, and Moving Averages), momentum (Example: RSI and Stochastic), volume (Example: On Balance Volume), and volatility (Bollinger Bands and Standard Deviation) indicators is another important classification.
Examples are Moving Average Indicator (MA), On-Balance-Volume Indicator (OBV), Exponential Moving Average Indicator (EMA), Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), Percentage Price Oscillator indicator (PPO), Parabolic SAR Indicator (PSAR), Average Directional Index (ADX), Accumulation/Distribution Line Indicator (A/D), Stochastic Oscillator Indicator, Bollinger Bands Indicators, Aroon Oscillator (AO), Standard Deviation Indicator, Fibonacci Retracement Indicators, and Commodity Channel Index (CCI).
This article has been a Guide to Technical Indicator. We explain its usage in stock trading (day trading and swing trading), its types like momentum, & example list. You can learn more about accounting from the following articles –