STOCK MARKET INDICATORS • History – Developed because of increased use of data mining and statistics. • Significance – Revolutionized way participants trade the market. • Function – Augment the Technical Analysis practice of Chart reading and Trend diagnosing. • Types - Some measure momentum; others measure volatility; and others focus on whether an equity is overbought or oversold relative to its recent price. • Indicators can create price action as well as merely measure it.
What is a Technical Indicator • A series of data points that are derived by applying a formula to the price data of a security. • Price data includes any combination of the open, high, low or close over a period of time. • Some indicators may use only the closing prices, while others incorporate volume and open interest into their formulas. • The price data is entered into the formula and a data point is produced.
What Does a Technical Indicator Offer? • A different perspective from which to analyze the price action. • Some, such as moving averages, are derived from simple formulas and the mechanics are relatively easy to understand. • Others, such as Stochastics, have complex formulas and require more study to fully understand and appreciate. • Regardless of the complexity of the formula, technical indicators can provide a unique perspective on the strength and direction of the underlying price action.
USE OF INDICATORS • The proper use of indicators require not only the knowledge of the indicator but also the knowledge of what patterns it is best suited for and how well the indicator works with the pattern. • Know what data [price, time, or quantity] is used by the indicator, i.e. >75% use only price and time, >15% use price and quantity and the balance, Hybrids, use all 3 data points. • You need to know what the indicator is telling about the price of the equity; and that it is never to be considered as more than one signal of the 2-3 that should be used to enter or exit a trade. • You also need to know indicators are used in conjunction with Chart reading.
1. Price - I personally think price action ( I use Japanese candle patterns) along with moving average and support and resistance. I try to go with the trend and identify the path of least resistance is where I want to be. 2. Volume - One of the best indicators of the conviction of traders. Volume ,placed in context with price movement, allows me to trade effectively. To measure the significance of volume, we need a baseline. What I am looking for is the % change over an average day. 3. Support and Resistance - I use support and resistance for entries and exits, as well as for clues about where the market is going. But support and resistance trading never becomes obsolete, because support and resistance levels are caused by human nature. They are a natural occurrence in all liquid markets, they always have been and they always will be. 4. Moving Averages - Moving averages are one tool to help you detect a change in trend. They measure buying and selling pressures under the assumption that no commodity can sustain an uptrend or downtrend without consistent buying and selling pressure. 5. Market Internals - For me the internals can help to show direction but what is important is to see how the internals are acting at key price levels. They will help you to confirm rejection or acceptance at support/resistance. Breadth can be used to see underlying strength or weakness. The up/down volume seems to give a broad sense of the market. • Price- Use Japanese Candle Patterns along with Moving Average and Support/Resistance. Try to go with the trend and identify the path of least resistance. • Volume - One of the best indicators of the conviction of traders. Volume ,placed in context with price movement, allows you to trade effectively. To measure the significance of volume, we need a baseline. Use the % change over an average day. • 3. Support and Resistance - Use support and resistance for entries and exits, as well as for clues about where the market is going. But support and resistance trading never becomes obsolete, because support and resistance levels are caused by human nature. • 4. Moving Averages - Moving averages are one tool to help you detect a change in trend. They measure buying and selling pressures under the assumption that no commodity can sustain an uptrend or downtrend without consistent buying and selling pressure. • 5. Market Internals - Internals can help to show direction but what is important is to see how the internals are acting at key price levels. They will help you to confirm rejection or acceptance at support/resistance. Breadth can be used to see underlying strength or weakness. The up/down volume seems to give a broad sense of the market.
6. Bollinger Bands - Bollinger Bands identify periods of high and low volatility. Use Bollinger Bands to confirm/identify a stock's trend. In conjunction with a moving average, you can use the bands to identify support and resistance. • 7. ADX (DMI + / -) - ADX indicator measures the strength of a trend • High readings indicate a strong trend; low readings indicate a weak trend. You want to be in stocks with high readings whether the underlying stock is in an uptrend or downtrend. When this indicator is showing a low reading, the underlying stock is probably about to establish a trading range (consolidation period). • 8. Stochastics - Adapt the oscillator to the market trend: When the market is trending up, then the signals with the higher probability of success are those in direction of the trend "Buy signals", on the other hand when the market is trending down, selling signals offer the lowest risk opportunities. A divergence occurs either when the indicator reaches new highs/lows and the market fails to do it or the market reaches new highs/lows and the indicator fails to do it. Both conditions mean that the market isn't as strong as it used to be.
9. Relative Strength Index (RSI) - A great leading indicator to time your trading signals. A stock is overbought if the RSI shows a level above 70. A stock is oversold if the RSI shows a level below 30. • 10. Moving Average Convergence Divergence (MACD) - MACD is a trend following momentum indicator. It also does a good job of finding a reversal in trends. The most simple way to use the MACD is to look for a crossover of the moving averages. When the MACD line crosses to the upside that is a bullish signal, conversely when the MACD line crosses to the downside that is a sell signal.
THE TREND • The Trend is more than your friend, it is the beginning point of Technical Analysis. • You must find the major trend. This is best done on a higher time frame line chart. Pick in accordance with your trading strategy. • Defined as Higher Highs and Higher Lows [UP] or Lower Highs and Lower Lows [DOWN] • Draw Trend Lines, 2-3+ bottom points in UP Trend [Support] or 2-3+ top points in DOWN Trend [Resistance] • Even in sloping trend lines, it is best to find areas where you can draw horizontal trend lines
Trend lines are typically used with price action. • however they can also be used with a range of technical analysisindicators such as MACD and RSI. • Trend lines can be used to identify positive and negative trending charts. • whereby a positive trending chart forms an up sloping line when the support and the resistance pivots points are aligned. • and a negative trending chart forms a down sloping line when the support and resistance pivot points are aligned. • Once you find the major trend always trade within the direction of the major trend.
MOVING AVERAGES • Moving Averages • A flexible most-commonly used indicators. • Popular mostly because of its simplicity. • It works best in a trending environment. • Introduction • In statistics, a moving average is simply a mean of a certain set of data. • In technical analysis, these data are in most cases represented by closing prices of stocks for the particular days.
The purpose and use of moving averages in technical analysis • A Moving average is a trend-following indicator. • Its purpose is to detect the start of a trend, follow its progress, as well as to report its reversal if it occurs. • Moving averages do not anticipate the start or the end of a trend. They only confirm it, but after the actual reversal occurs. • As these indicators are based solely on historical data. • The less days the sooner it can detect a trend's reversal. It is because of the amount of historical data, which strongly influences the average. • A 20-day moving average generates the signal of a trend reversal sooner than the 50-day average. • The fewer days in the moving average's computation, the more false signals we get. • Hence, use a combination of several moving averages, which all have to yield a signal simultaneously. • Amoving average's lag behind the trend cannot be completely eliminated.
Trending Signals • Signals are generated when prices intersect lines, i.e. moving above [Bull] or below [Bear] • With multiple lines, shorter crosses longer [Bull] or longer crosses shorter [Bear] • Using 3 lines reduces false signals • Use with another indicator that measures trend strength, i.e. ADX • SMA is arithmetic mean • EMA places more weight on new data while reflecting historical data
Oscillators • Indicate possible change in trend • Work best in sideways markets • Generally placed under price charts • Values oscillate in a certain range • Good for analysis of current market situation within its range • Used as a leading indicator • Look at current reading for strength of trend, value^trend^ • Look at trend • Look at imbalance in market – overbought/oversold • Steep rise will probably lead to a short term correction or at least a loss of momentum in the trend.
Oscillators • Try to find divergences between indicator, market price and volume • i.e. market price>HH but MA falls is bearish signal • Or Oscillator crosses centerline to either OB or OS, for RSI >80 <20 • RSI measures increase or decrease in price for period of time, usually set at 14. [I use 21 because it is just beyond 1 month of data • ADX – average directional index measures trend strength without regard to trend direction. • Plus Directional Movement (+DM) and Minus Directional Movement (-DM) form the backbone of the Average Directional Index
Directional movement is positive (plus) when the current high minus the prior high is greater than the prior low minus the current low. This so-called Plus Directional Movement (+DM) then equals the current high minus the prior high, provided it is positive. A negative value would simply be entered as zero. Directional movement is negative (minus) when the prior low minus the current low is greater than the current high minus the prior high. This so-called Minus Directional Movement (-DM) equals the prior low minus the current low, provided it is positive. A negative value would simply be entered as zero.
MACD • Moving Average Convergence-Divergence (MACD) indicator is one of the simplest and most effective momentum indicators available. • The MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. • As a result, the MACD offers the best of both worlds: trend following and momentum.
MACD • MACD - convergence and divergence of the two moving averages. • Convergence - the moving averages move towards each other. • Divergence - the moving averages move away from each other. • The shorter moving average (12-day) is faster and responsible for most MACD movements. • The longer moving average (26-day) is slower, less reactive to price changes in the underlying security. • MACD Line oscillates above and below the zero line [centerline.] • These crossovers signal that the 12-day EMA has crossed the 26-day EMA. • The direction depends on the direction of the moving average cross. Positive MACD indicates that the 12-day EMA is above the 26-day EMA. • This means upside momentum is increasing. • Negative MACD values indicates that the 12-day EMA is below the 26-day EMA. • This means downside momentum is increasing.
SUMMARY • Indicators are a powerful supplement to Charting • Indicators can give false signals • Use multiple indicators [2-3] to confirm entry • Begin by finding Trend • Trade in direction of Major Trend • Use Candlesticks with Indicators to select a trade • Have a definite entry and exit at time of selection