Education

Introduction to technical indicators

Our technical indicator course serves the purpose of introducing the concept of technical analysis indicators and explain how to use them in trading. We will cast some light on what are technical indicators, clarify differences between different groups of indicators and look for advantages and disadvantages that indicators may bring to trader. We will also explain the difference between general indicators and oscillators and explain you how to interpret data provided by both groups. Also, the course is complemented with practical examples of how indicators can be applied on various groups of asset and market conditions.

What Is a Technical Indicator?

A technical indicator is a serious of values received after applying a formula on the price of the financial instrument. The data derived from the chart is usually limited to the combination of open, high, low and closing prices collected from different time periods. Some indicators use closing prices at the core of the formula while other incorporate complex measures like Standard Deviation into their formula.

For example, one of the most commonly used and easiest to interpret forex technical indicators, a Simple Moving Average (SMA), uses combination of closing prices from recent periods and divides the received value into the number of periods. Let’s say, the average of 3 closing prices is one data point [(41+43+43) / 3 = 42.33]. But one single data point is usually not enough for consistency and accuracy of analysis and that is why many indicators create a series of different data points and derive values by combining them together.

Technical indicators are represented in a graphical form, usually as overlays applied over price charts. Once placed on the chart, the indicator can be further configured to suit particular security or trading strategy. For example, when using the Bollinger Band Indicator, traders can configure the tool in number of ways by selecting average period and percentage of standard deviation.

Above is an example of Bollinger Bands indicator applied over the chart of EUR/USD

What advantages technical indicators give?

Technical indicators offer different angle from which chart analysis can be approached. Indicators can make a difference between success and failure of trade by providing vital outlook on the underlying price condition. Some, like RSI can give vital perspective on whether current price is overbought or oversold and warn of impending reversals. Others, like Stochastic Oscillator, generate signals when particular conditions are met. Regardless of the complexity, technical indicators can provide a unique perspective on the strength and direction of the underlying price action. Determining the most useful technical indicator is a science all into itself and may depend on trader’s style and underlying market conditions. Therefore, traders need to have a solid knowledge of the subject to pick the right tools.

Why Use Indicators?

Indicators do 3 simple things; they alert, confirm and predict.

1. Indicators can give you warning signs otherwise not visible on the chart and encourage you to do more analysis before making an order. If for example RSI is approaching 70 – price is getting overbought and reversal is likely to happen. Or, if there is an apparent divergence between price direction and indicator value – get ready for impending price reversal.

2. Indicators can also serve as reliable confirmation tools. For example, some technical indicators can hardly give any viable advice on future price movements without other tools complementing them. For example, a resistance breakout can be confirmed by a corresponding moving average crossover.  Or for example, a divergence visible on the Stochastic Oscillator can be further substantiated by price’s recent failure to move below the lower Band of Bollinger band indicator.

3. And finally, data points provided by indicators can give a glimpse into the future and help investors predict future prices.

Tips for Using Indicators

Indicators indicate. This may sound straightforward, but sometimes traders ignore the price action of a security and focus solely on an indicator. Indicators filter price action with formulas. As such, they are derivatives and not direct reflections of the price action. This should be taken into consideration when applying analysis.

Another thing worth taking into account that indicators don’t take fundamental factors into consideration. As such, always check latest market news and never let important announcements out of your sight. Remember, that strong economic announcements like GDP and unemployment rates may significantly reduce the reliability of data derived from technical indicators.

And finally, it is highly recommended not to group tools into one big technical indicator list especially if you’re just halfway through basic education. Using many indicators at the same time may be confusing to say the least and do more harm than good.

Looking for best technical indicators – our extensive selection of articles on the subject will help you choose the right tools.