Indicators are calculations, like many other of the concepts involved in technical analysis. They are based on different factors, such as the volume and price of a security and help determine volatility, momentum, money flow and more. Indicators are additional sources of information that help confirm price movements, trends and to determine the quality of the data in different charts.
Two Distinct Sorts of Indicators
There are two distinct sorts of indicators – leading and lagging. Leading indicators, as the name suggests, precede price movements and have something of a predictive quality, while lagging indicators come after and are used mainly as confirmation tools. Normally, a leading indicator is strongest when we dont have any obvious trends or fluctuating price movements. This is quite natural because it is then when they can most comfortably point to a direction and make a prediction due to the lack of trends. Unlike leading indicators, lagging indicators are useful especially when there is a trend simply because they can easily confirm it.
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As far as indicator construction is concerned, there are also two types – those that fall into a specific range and those that dont. Oscillators are indicators that fall into the specific range. They are among the most common indicators. When the security is near either end of the range (top or bottom, if you will), then this signals of overselling or overbuying. If the security is overbought, then it will be near the top of the range and if its oversold, it will near the bottom of the range. The indicators that are not bound in the range can still signal for buying or selling, but the way they do it can vary significantly.
There are two main ways in which indicators can be used to form buy or sell signals. The first one is through crossovers. Crossovers form when the price moves through a moving average, or two moving averages cross over one another. Crossovers are by far the most used in the decision making process. The alternative is way is through divergence. Divergence is an interesting phenomenon characterized by the fact that the direction of a trend and the direction of the indicator are moving in alternate directions. This is a clear signal that the trend is weakening.
As weve already mentioned, indicators are an invaluable source of additional information and can tremendously help the trader to make the right choice. Indicators are useful for determining momentum, trends and many other facets of an asset. Even though there are those traders who only use one indicator in their process, indicators are best used in combination with patterns, trends and other indicators.
This popular indicator helps the measurement of the money flows in an asset. The main goal here is to determine the ration of buying to selling, and the way to achieve this is to compare the price movements of a period to the volume of the same period. In other words, the calculations look something like this:
This indicator can help traders determine how much buying or selling of a certain asset there is. Its no a bounded indicator, but it helps identify the tendency toward buying/selling the asset, which in turn aids the trader in making up his own mind on what to do with the asset. The trends in this indicator are very important and often used.
Average Directional Index
The average directional index is a lagging indicator, meaning that its used during the times of a trend. Its main purpose is to determine whether a current trend is strong or not. This indicator is rarely used to identify a trends direction, but its very efficient in determining the strength of a trend.
The ADX has two components, each of which measures a price movement – the positive and negative directional indicators. The positive directional indicator (+DI) is used for an uptrend while the negative directional indicator (-DI) is used for a downtrend. They measure the strength of a trend on the scale of 1 to 100. If a trend has readings lower than 20 according to the ADX, then this means that the trend is weakening. Naturally, if the exhibited values are above 40, this means that the trend is standing strong.