What is a ‘Technical Indicator’
Technical indicators are used to predict the future price levels, or simply the general price direction, of a security by looking at past patterns. Examples of common technical indicators include Moving Average. Bollinger Band, Relative Strength Index, Stochastics Oscillator, MACD and so on.The most effective uses of technicals for a long-term investor are to help identify good entry and exit points for the stock by analyzing the long-term trend. Technical analysis is a trading tool employed to evaluate securities and attempt to forecast their future movement by analyzing statistics gathered from trading activity, such as price movement and volume.
Technical indicators represent a statistical approach to technical analysis as opposed to a subjective approach. It is 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. Indicators generate buy and sell signals by calculating the past prices ot the markets.
For example, the average of 14 days closing prices of EUR/USD is one data point [(1.1607+1.1607+1.1584+1.1592+1.1640+1.1663+1.1665+1.1796+1.1789+1.1769
+1.1788+1.1731+1.1737+1.1740)/ 14 = 1.0850].
Some most powerful Indicators are given bellow.
A moving average (MA) is a price calculation to analyze the data points by creating series of averages of different subsets of the full data set. It smooth the price data to form a trend following indicator, moving averages help smooth price action and filter out the noise. A moving average is commonly used with time series data to smooth out short-term fluctuations and highlight longer-term trends or cycles. The most common applications of moving averages are to identify the trend direction and to determine support and resistance levels.
When the market is trending up, you can use the moving average to identify the trend and the right time to buy and when the market is trending down, you can use the moving average to identify the trend and the right time to sell. The moving average is a plotted line that simply measures the average price of a currency pair over a specific period of time, like the last 14 days, 20 days, 50 days, 100 days, 200 days or year of price action to understand the overall direction.
The two most popular types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). These popular two moving averages can be used to identify the direction of the trend of any financial markets.
Simple Moving Average
A simple moving average (SMA) is the simplest type of moving average calculated by adding the closing price of any security for a number of time periods and then dividing the total by the number of time periods.
Simple Moving Average Calculation
The simple moving average (SMA) is an average of the last n prices, where n is the number of periods
(P1 + P2 + P3 + ……… + Pn) / n
A14-period SMA with prices of 1.1607,1.1607,1.1584,1.1592,1.1640,1.1663,1.1665,1.1796,1.1789,1.1769,1.1788,
1.1731,1.1737& 1.1740 gives a moving average of 1.0850 using the calculation [(1.1607+1.1607+1.1584+1.1592+1.1640+1.1663+1.1665+1.1796+1.1789+1.1769
+1.1788+1.1731+1.1737+1.1740)/ 14 = 1.0850].
Exponential Moving Average
An exponential moving average (EMA) is a type of moving average that is similar to a simple moving average, except that more weight is given to the latest data.
Calculation of Exponential Moving average
To calculate EMA, take current price & multiply it by constant (C). Take previous period`s EMA & multiply it by 1 minus that constant (C). Add the two values together.
EMA(Current)=C*Price(Current)+(1-C)*EMA (Previous Period)
How to Use Moving Averages
A rising moving average indicates that the current market is in an uptrend, while a declining moving average indicates that market is in a downtrend. When moving average is going upward then we should find the support area to buy the security, similarly when moving average is going downward then we should search the resistance area to sell the security.
A Bollinger Band is a technical tool developed by John Bollinger in the 1980s as well as a term trademarked by him in 2011. Bollinger Bands are a volatility Indicator, a volatility bands placed above and below a moving average. Volatility is based on the standard deviation, which changes as volatility increases and decreases.The bands automatically widen when volatility increases and narrow when volatility decreases.The outer bands are usually set 2 standard deviations above and below the middle band.
Trading Uptrends with Bollinger Bands
Bollinger bands help assess how strongly an asset is rising upward.When the price is in a strong uptrend it will typically touch or run along the upper band. When the price is in a strong uptrend it shouldn’t touch the lower band. If it does that’s a warning sign for a reversal.