Types of Technical Indicators
Published: 5 June 2008
By Sunil Tinani Leave a Comment
Updated: 20 June 2008
There are many technical indicators used by analysts to study market indices and predict stock price behaviour. But one thing common to all indicators is that if understood correctly they can help predict stock trends and can be used even by the layman to enter into profitable trades. They have been proven correct time after time for many decades and their tried-and-tested formulas are relevant even today.
Broadly speaking, all popular technical indicators fall into one of the following five categories in order of their increasing complexity:
- moving average indicator;
- trend indicators;
- volume indicators;
- volatility indicators;
- momentum indicators.
This image shows a number of technical indicators being used to analyse the Microsoft share performance. (click here for a larger image)
Moving averages are the most basic and simplest technical indicators, and should be used as the starting point if you are a beginner. You can then gradually move on to trend indicators and volume indicators, which are also quite simple to grasp. However, volatility indicators and momentum indicators are relatively complex and should be used only after getting a thorough grip on the first three indicators.
Here follows a brief introduction to the various types of technical indicators. The details of each make the subject matter of future articles.
1. Moving Average (MA) indicators
If you know a little about the stock market, you’d have observed that stock prices fluctuate every second. If such fluctuations are plotted on a chart while technically analysing a stock, a technical chartist will come up with nothing more than a clutter of scattered data points.
This is where MA comes in. Technical chartists use MA to smooth the stock’s price movements on the charts by plotting an average price of the stock on the charts – the average could be day’s average, or average of day’s high, day’s low, or day’s opening or closing price. Chartists observe the MA over a period, which can be as low as 15 days or it can be as high as 200 days. Several theories are then applied to the MA curves on the chart – for example, if a 15-day MA crosses a 100-day MA, then it spells an upward trend, or if the short-term MA falls below the long-term MA, then it’s a bearish signal.
MA is the most common and simplest of all technical indicators that can help you identify a profitable trade.
2. Trend Indicators
They say the trend is your friend, and they are right. If you can identify a stock’s trend – upward or downward – you can make a killing on the stock provided you move in and exit while you’re still rolling in profits. Trend indicators help you identify the trend of a stock by evaluating the perseverance of a stock’s price towards a certain direction (upward or downward).
3. Volume Indicators
A share can zoom from $1 to $2 in a single session, but if it is not backed by good volumes, then there may be reason to believe that insider forces are involved in manipulating the price. Take another example: Let us assume you own a stock that quotes at $100 with wafer thin volumes. When you try to sell such a stock, its price will keep breaking downwards, maybe to $70 – such stocks have no depth, and you will soon realize that dealing in stocks without reasonable volumes can be dangerous.
Therefore, volumes form the core of any stock and it is equally important to analyze volumes in addition to stock price. Thankfully, volume indicators can help you out here – these indicators analyze the volume action or a combination of the price–volume action. They give pointers to where the stock is headed and alert you if there’s profit to be made.
4. Volatility Indicators
Every stock touches a high and a low every trading day. When there is a large swing in its price for some days, it is considered to be a volatile stock. Going long or short on a volatile stock without knowing where its headed is like losing your way while running from a forest fire – one wrong move can burn a massive hole in your bank balance.
Volatilty indicators allow a trader to spot potential upward or downward trends or breakouts in a stock by measuring the stock’s volatility using a variety of computational methods.
5. Momentum Indicators
Many stocks go up or fall down with substantial strength in their volumes and with significant changes in their price. The speed at which they move, the force with which they are pushed up or down by their volumes, and the dramatic changes in their price over a specified period all combine to make up the term “momentum”.
Stocks in momentum mode swing strongly either way, and day traders and short-term traders can make a pile of cash if they can identify the momentum in a stock and it’s probable direction. Momentum indicators help them do precisely that.
All important and relevant indicators falling in the aforesaid categories will be explained in future articles so stay tuned.