Welcome back to Part 2 of our Overview of the Technical Analysis!
Last week we started discussing our Trading Top Ten of Technical Analysis! We covered the three most important elements of technical analysis. These are Trend, Support/Resistance Levels and Japanese Candlesticks (with Patterns)! Make sure to check it out here in case you've missed it!
This week, we are going to focus on the remaining seven indicators that we believe every trader should know of!
It is important to remember that all indicators discussed here do not predict future price movements. They help us better understand the current direction of the price and can be used to forecast future price changes based on past data.
4. Moving Averages: Simple Moving Average (SMA) & Exponential Moving Average (EMA)
Let's start with Moving Average (MA) as it is the most common technical indicator used by traders. In simple terms, MA is a tool used to identify and display trends clearly without the noise of short-term price fluctuations.
By looking at a MA you are looking at the average closing price for the pair you are analysing over the last 'X' number of periods (also referred to as the 'length' of a Moving Average). You should always adjust the 'length' of the MA in line with the strategy and the timeframe you use. When there are too few data points (shorter length), the MA will stay close to the current price, while too many data points (longer length) may result in a trend being 'too smooth' providing little to no value to some strategies.
Simple Moving Average (SMA) is one of the easiest averages to calculate. It is the average closing price over a specific period. If you're looking at 62 SMA you would add up the closing prices of the last 62 candles and divide it by 62. The same principle applies when looking at 5 SMA, 30 SMA, 200 SMA, and so on! With SMA you have to be careful about the price spikes (i.e. unexpected changes caused by the news) as they will affect the trend you see and may lead to some false signals!
Similarly to SMA, the Exponential Moving Average (EMA) will look at the average closing price over a specific period. Unlike SMA, EMA will emphasise more on the most recent periods. As such, EMA provides a more accurate representation of the latest price action. It is not as heavily affected by the unexpected spikes from the past!
5. Moving Average Convergence Divergence (MACD)
Moving Average Convergence Divergence (MACD) aims to identify changes that are indicating a new trend! It uses
slower moving average and
the moving average of the difference between the faster and slower moving averages.
The default setting for most terminals would see you using 12,26,9 as the MACD parameters!
MACD is made up of three components:
the MACD line (distance between two moving averages)
the Signal line (moving average of the MACD line that identifies changes in price momentum indicating possible buy/sell signals)
the Histogram (a graphical representation of the difference between the signal line and the MACD line)
Traders using MACD are looking for a faster MACD line to cross through the slower signal line to confirm their entry.
6. Keltner Channels
Keltner Channels is a volatility-based indicator that aims to identify overbought and oversold levels relative to the moving average. Outer bands are based on the Average True Range (ATR), while the middle line is an Exponential Moving Average (EMA).
With Keltner Channels, you can see and better understand the dynamic resistance (top band) and the dynamic support (bottom band).
Price reaching the top band would indicate a bullish trend while reaching the bottom band would indicate a more bearish move.
Traders can use these dynamic levels to find better entry and exit levels!
Braking through these dynamic levels usually require a strong trend and traders expect a continuation of the move rather than its reversal.
The most common parameters used with Keltner Channels are 2 x ATR (10) for both outer lines and the 20 EMA for the middle lane.
7. Fibonacci Retracement
Fibonacci Retracement is an indicator that traders use to find potential support and resistance areas. The most important Fibonacci Levels are:
0.236, 0.382, 0.618 & 0.764 for Retracement and 0, 0.382, 0.618, 1.000, 1.382 & 1.618 for Extension.
Luckily, most of the trading platforms will calculate these levels for you. 'All you need to do is to identify Swing High & Swing Low points!
This indicator is best used in a trading market! It is based on the simple premise that after the price has moved with a new trend, it will retrace back to a certain previous price level before resuming the direction of the trend!
It is important to remember that Fibonacci Retracement is one of the most widely used indicators and there may be a lot of orders placed in the same areas of interest. Don't be surprised to see increased volume and/or volatility around those key support/resistance levels.
8. Bollinger Bands
You will see a lot of familiarity with Keltner Channels when using this indicator. Bollinger Bands is a volatility-based indicator that aims to identify overbought and oversold levels relative to the moving average. Outer bands are based on the Standard Deviation (SD), while the middle line is a Simple Moving Average (SMA).
Once again, these outer bands act like dynamic support (bottom band) and resistance (top band) levels.
Bollinger Bands will also provide you with a clear picture of the perceived volatility of the asset you're looking at. The wider the bands, the higher the volatility and the narrower the bands the lower the volatility. It is best to be used with ranging markets so it is important to avoid trading when there is a strong trend (the bands are expanding).
9. Stochastic Oscillator
A Stochastic Oscillator is a technical indicator showing the momentum and trend strength on a scale of 0 to 100.
It provides us with clear visual information when the asset is overbought (above 80) and oversold (below 20). Traders using Stochastic Oscillator are looking for their Buy entries when the market is oversold and would execute Sell positions when the market is overbought aiming to catch a reversal and secure some profits.
It is important to remember that the asset can remain overbought or oversold for long periods and you should never carelessly buy/sell based on this one indicator alone (especially when a strong trend is present)!
10. Relative Strenght Index (RSI)
The Relative Strenght Index (RSI) is our last indicator covered in today's lesson! This indicator helps us identify the momentum and evaluate the strength of the market. Similarly to the Stochastic Oscillator, it uses a scale from 0 to 100 and tells us if the asset is overbought (over 70) or oversold (under 30).
Traders using RSI are looking for their Buy entries when the market is oversold and would execute Sell positions when the market is overbought aiming to catch a reversal and secure profits.
Some Traders would also look for centerline crossovers (50) and would look to identify bullish (line crosses 50 and is heading towards 70) or bearish (line crosses 50 and is heading towards 30) signals early.
RSI can also be used to confirm the formation of a trend! Once again, traders are using the centerline (50) to confirm whether the trend has been formed before entering their positions.
We hope you've enjoyed learning about some of the most important indicators out there! Make sure you study them more and start using a mixture of indicators when analysing the market! Never rely on just one indicator when looking for your entries!
Make sure to join us next week as we continue looking at Market Analysis focusing on News & Fundamentals!