Understanding trading indicators

What do you need trading indicators for?

A lot of information can be derived from the course history, which can help you to make correct trading decisions. However, trading indicators are often used to support this. There are a variety of technical trading indicators that you can use for your trading strategy.  Below you will find out which trading indicators are the most common. 

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Trading Indicators:

  1. Moving averages
  2. Moving Average Convergence&Divergence – MACD
  3. Bollinger bands
  4. Relative Strength Index – RSI
  5. Stop and Reverse System – Parabolic SAR
  6. Ichimokou Cloud
  7. Momentum Indicators
  8. Stochasic oscillator
  9. Average True Range – ATR Indikator
  10. Average Directional Index – ADX Indikator
  11.  

1. Moving averages

Moving averages serve as technical trading indicators to show how the price of a market has developed on average over a period of time. Moving averages are often used as indicators to show trends, detect trend reversals and provide trading signals. There are several different types of moving averages, but they all create a single line that can show you in which direction a price has moved.

Calculation of the moving average

The Simple Moving Average (SMA) calculates an average of the last “n” (n = number) prices, where n represents the number of periods (candles) for which you want the average:

Simple moving average = (P1 + P2 + P3 + P3 + P4 + …. + Pn) / “n”

For example, a four-period SMA with prices of 1.2640, 1.2641, 1.2642 and 1.2641 gives a moving average of 1.2641 using the calculation [(1.2640 + 1.2641 + 1.2641+ 1.2641) / 4 = 1.2641].

Golden Cross

The SMA value is the average price for the number of periods in the SMA calculation. Common SMA settings are 8, 20, 50, 100 and 200. For example, if you use an SMA with 100 periods, the current value of the SMA in the graph is the average price of the last 100 candlesticks. A cross between the 100 and 200 average lines is also known as the ‘Golden Cross’.

Exponential calculation of the moving average

Exponentielle Berechnung des gleitenden Durchschnitts - TC24

The exponential moving average (EMA) is a weighted average of the last “n” prices, with the weight decreasing exponentially with each previous price/period. In other words, the formula gives more weight to the current price than past prices.

Exponential moving average = [closing price – previous EMA] * (2 / n+1) + previous EMA

For example, a four-period EMA with prices of 1.5554, 1.5555, 1.5558, and 1.5560, the last value being the youngest, gives a current value of 1.5558 using the calculation [(1.5560 – 1.5558) x (2/5) + 1.5558 = 1.55588].

Calculation via the chart platform

As with the SMA, the chart platform takes over all calculations. Select EMA from the list of trading indicators on a chart platform and apply it to the chart. Then you determine the size of the calculation period, for example 15, 50 or 100 candles.

The EMA adapts faster to price changes than the SMA. For example, if a price changes direction, it reverses direction faster than the SMA. This is because the formula gives more weight to recent prices and takes less account of past prices.

Calculation of the weighted moving average

The Weighted Moving Average (WMA) gives you a weighted average of the last “n” prices, with the weight decreases with each previous price. This works similarly to the EMA, but the calculation of the WMA is different.

gewichteter gleitender Durchschnitt - TradersClub24

Use and interpretation of the moving average

Moving averages can be used as trading indicators for both analysis and trading signals. For analysis, all moving averages help to highlight the trend.

Price is below MA

If the price is below its MA, this is seen as a sign that the price is traded lower than the average over the period under consideration, which helps to confirm a downward trend. In other words, if the price is below its MA, it shows that the price is weakening compared to what it was in the past.

Price is above MA

If the price is above its MA (Moving Average), this means that the price is traded higher than it did on average over the period under consideration. In other words, if the price is above its MA, this indicates that the price is getting stronger compared to what it was in the past, as the latest price is now above average. This confirms an upward trend.

Moving Avarage graphic-600x380

A longer-term and a short-term moving average, for example 20 and 50 periods, can be added to a chart at the same time. If the 20-period MA rises above 50, this indicates that the short-term price momentum is moving upwards. If the 20-period MA falls below 50, this indicates that the short-term price momentum is moving downwards.

MAs in other trading indicators

MAs can also be integrated into other trading indicators to deliver trading signals. An EMA can provide buy signals when combined with Keltner Channels, for example. A strategy can include buying near the EMA if the trend increases and the price falls back from the top of the Keltner Channel.

One type of MA is no better than others; they only calculate the average price differently. Depending on which strategy you use, one type of MA can work better than another.

Recommendation

It is recommended that you adjust the settings slightly for each market. A 50-period SMA can provide great signals for one market, but it doesn’t work well for another. Or an EMA with 20 periods can help to detect the trend in one currency pair, but not another. All MAs are just tools and the trader needs to adopt the interpretation as trading indicators never work well all the time or under all market conditions.

MACD graphic-600x380

2. MACD

The Moving Average Convergence&Divergence  (MACD) was developed in the 1970s by Gerald Appel and is one of the most popular trading indicators used today. Traders use the MACD to determine trend direction, momentum and possible inversions. It is used to confirm trades based on another strategy, but also provides its own trading signals. The MACD fluctuates above and below the zero line when the moving averages converge, cross, and diverge. Traders can search for signal line intersections, centerline intersections, and divergences to find signals. Because the MACD is not limited in scale down and up, it is not particularly useful for identifying overbought and oversold prices.

Calculation

The MACD is the 12-day Exponential Moving Average minus the 26-day EMA. These moving averages use closing prices. A 9-day EMA of the MACD line is recorded with the indicator as a signal line to identify curves. The MACD histogram represents the difference between the MACD and its 9-day EMA, the signal line.

The histogram found in same indicator settings is positive if the MACD line is above its signal line and negative if it is below it. Values 12, 26 and 9 are the typical setting of the MACD, but different values can be used depending on your trading style and goals.

Identify convergence, divergence and crossovers

From the chart you can see that the fast line crosses below the slow and therefore indicates a downward trend. When crossing the lines, the histogram may temporarily disappear. This is due to the fact that the difference between the lines at the time of the cross is 0. When the downtrend starts and the fast line deviates from the slow one, the histogram gets larger, which is a good indication of a strong trend. As with MACD, the MACD histogram is designed to detect convergence, divergence, and crossover.

MACD seconde graphic-600x380

The MACD histogram

The MACD histogram, on the other hand, measures the distance between the MACD and its signal line. The histogram is positive when the MACD is above its signal line. Positive values increase as the MACD continues to deviate from it (up). Positive values decrease when MACD and its signal line converge. The MACD histogram crosses the zero line while the MACD crosses below its signal line. The trading indicator is negative if the MACD is below its signal line. Negative values increase as the MACD continues to deviate from its signal line (down). So then, the negative values decrease when the MACD converges on its signal line.

3. Trading Indicators: Bollinger Bands

The trading indicators Bollinger Bands developed by John Bollinger are volatility bands that are above and below a moving average. Volatility is based on the standard deviation, which changes with increasing and decreasing volatility. The bandwidths automatically widen as volatility increases and converge as volatility decreases. This dynamic of Bollinger Bands also means that they can be applied to different securities with the default settings, including Forex currency pairs. For signals, Bollinger bands can be used to identify M-Tops and W-Bottoms or to determine the strength of the trend.

Recognising Bollinger bands

Bollinger bands consist of a middle band with two outer bands. The middle band is a simple moving average that is typically set to 20 periods. A simple moving average is used because the standard deviation formula also uses a simple moving average. The review time for the standard deviation is the same as for the simple moving average. The outer bands are usually set with 2 standard deviations above and below the center band.

Adjust settings

The settings can be adjusted to the characteristics of certain securities or trading styles. Bollinger recommends making small adjustments to the standard deviation multiplier. Changing the number of periods for the moving average also affects the number of periods used to calculate the standard deviation. Therefore, the standard deviation multiplier requires only small adjustments. An increase in the moving average period would automatically increase the number of periods used to calculate the standard deviation and justify an increase in the standard deviation multiplier.

Bollinger suggests increasing the standard deviation multiplier for a 50-period SMA to 2.1 and lowering the standard deviation multiplier for a 10-period SMA to 1.9.

bollinger band graphic-600x380

Signal: Hiking in the bands

Movements above or below the bands are not signals in themselves. As Bollinger puts it, movements that touch or exceed the bands are not signals, but “tags”. At first glance, a movement to the upper band means strength, while a strong movement to the lower band represents weakness. Momentum oscillators work similarly. Overbuying is not necessarily bullish. It takes strength to reach overbought values and overbought conditions can expand in a strong upward trend.

Movement to the upper band

Likewise, prices can be “walk the band” with numerous accents during a strong upward trend. The upper band is 2 standard deviations above the simple moving average of 20 periods. It takes a fairly strong price movement to cross this upper band. A touch of the upper band, which occurs after a Bollinger band has confirmed W-Bottom, would signal the beginning of an upward trend.

Bewegung zum unteren Band

So wie ein starker Aufwärtstrend zahlreiche obere Band-Tags hervorbringt, ist es auch üblich, dass die Preise während eines Aufwärtstrends nie das untere Band erreichen. Der 20-tägige SMA dient manchmal als Unterstützung. Tatsächlich bieten Dips unter dem 20-tägigen SMA manchmal Kaufgelegenheiten vor dem nächsten Tag des oberen Bandes.

Movement to the lower band

Just as a strong uptrend produces numerous upper band tags, it is also common for prices to never reach the lower band during an uptrend. The 20-day SMA sometimes serves as support. In fact, dips under the 20-day SMA sometimes offer buying opportunities before the next day of the upper band.

4. RSI

RSI graphic-600x380

Like the MACD, the Relative Strength Index (RSI) is one of the MomentumTrading indicators that measures the extent of recent price changes to analyse overbought or oversold conditions. The RSI provides a relative assessment of the strength of the recent price development of a value. The RSI values range from 0 to 100. The standard period for comparing up and down periods is 14, as in 14 trading days. The traditional interpretation and use is that RSI values of 70 or above indicate that a value is overbought or overvalued and can therefore be prepared for a trend reversal or a corrective price loss. An RSI value of 30 or below is commonly interpreted as an indication of an oversold or undervalued condition that can mean a reversal of the trend or a corrective upward price reversal.

Relative Strength Index - RSI

Sudden large price movements can lead to false buying or selling signals in the RSI. Therefore, it is a good place to use it with refinements of its application or in conjunction with other technical indicators.

Some traders use more extreme RSI values than buy or sell signals, such as values above 80 to indicate overbought conditions, and values below 20 to display oversold conditions.

The RSI is often used in conjunction with trendlines because the support or resistance of the trendline often matches the support or resistance values in the RSI value.

Divergences with the RSI indicator

According to Wilder, divergences signal a potential reversal point because the directional momentum does not confirm the price. A bullish divergence occurs when the market reaches a lower low and the RSI reaches a higher low. The RSI does not confirm the low and shows an increasing dynamic. A decline in divergence occurs when a higher high and the RSI has a lower high. The RSI does not confirm the new high and shows a weakening dynamic.

Before getting too excited about divergences as big trading signals, it is important to note that divergences are misleading in a strong trend. A strong upward trend can have numerous bearish divergences before a top actually comes about. On the other hand, bullish divergences can occur in a strong downward trend – and yet the downward trend continues.

5. Parabolic SAR

The parabolic SAR is one of the technical trading indicators and is used to determine the price direction of a value and to indicate when the price direction changes. The parabolic SAR was developed by Welles Wilder, the inventor of the Relative Strength Index, and is also known as the “Stop and Reverse System”.

Parabolic SAR im Chart

In a chart, the trading indicator appears as a series of points placed either above or below the candlesticks. A point below the price is considered a bullish signal. Vice-versa, a point above the price is used to show a bearish signal and that the momentum is likely to remain downwards. Turning the points around indicates that a possible price change is underway. For example, if the points are above the price, if they fall below the price, this could indicate a further price increase.

If the price of a value rises, the points will also rise; first slow and then faster and faster with the trend. The SAR starts to move a little faster as the trend develops and the points soon pick up the price.

Parabolic SAR for setting stop loss orders

The parabolic SAR is also a method for setting stop loss orders. When a value increases, move the stop loss to match the parabolic SAR indicator. The same concept applies to short trade – with the price falling, so does the indicator. Move the stop loss so that it corresponds to the level of the indicator after each candlestick.

This indicator is mechanical and will always give new signals to trade long or short. It is up to the trader to determine which signals to accept and which to leave alone. For example, in a downtrend, it is better to take only short selling, as shown in the graph above, as well as the buy signals.

Trading Indicators to Complement the Parabolic SAR

In trading, it is better to have several indicators confirm a particular signal than to rely on only one particular indicator. Complement the SAR trading signals with other trading indicators, such as a stochastic, moving average or the ADX.

For example, SAR sales signals are much more convincing when the price is below a long-term moving average. This suggests that sellers have control over the direction and that the current SAR sales signal could be the beginning of another wave.

 

Likewise, if the price is above the moving average, focus on taking over the buy signals (points move downwards).

6. Ichimokou Cloud

The Ichimoku Cloud is a trading indicator that gives you everything you need to know about a price history, including direction, momentum, dynamic support and resistance levels, and even trading signals. The Japanese name , Ichimoku Kinko Hyo – means “a look at the equilibrium graphic.” This indicator was developed by Goichi Hosoda, a Japanese journalist who published it in the late 1960s. Ichimoku offers a trader more information than a standard candlechart.

It is intended to provide relevant information at a glance by using moving averages (tenkan-sen and kijun-sen) to display bullish and bearish crossover lines. The “clouds” (kumo, in Japanese) form between the ranges of the average of the Tenkan-sen and Kijun-sen diagrams of six months in advance (senkou span A) and the center of the 52 periods at the high and low point (senkou span B) of six months in advance.

There are five calculations that generate the Ichimoku Cloud:

  • Tenkan-sen = (9-day high + 9-day low) / 2
    • Kijun-sen = (26-day high + 26-day low) / 2•
    Senkou span A = (Tenkan-sen) sen + Kijun-sen) / 2•
    Senkou Span B = (52-day high + 52-day low) / 2•
    Chiku range = closing price of 26 days from the past•
    Ichimoku Cloud Signals

The general trend is upwards when prices are above the cloud; down when they are under the cloud or in the cloud itself. When the Senkou span A rises over the Senkou span B, the trend goes up more and is typically colored green. When the Senkou span B rises over the Senkou span A, the trend is more downwards and is marked with a red cloud.

Ichimoku Cloud: Benefits for Merchants

Traders will often use the Senkou “cloud” as an area of support and resistance, depending on the relative position of the price. The Senkou “Cloud” provides support levels that can be projected into the future. This makes the Ichimoku Cloud different from many other technical indicators that only provide support and resistance levels for the current date and time.

In summary: Trend strength or weakness

When the span A (green cloud) moves upwards and away from span B (red cloud), it means that the uptrend gains momentum. When span A moves down and away from span B, this indicates that the downtrend is accelerating. In other words, a thickening cloud helps confirm the current trend. A very thin cloud represents indecision and a possibly weak or weaker trend.

Support and resistance

The cloud is projected from 26 candles to the right of the current price and gives an idea of where support and resistance could develop in the future. During an uptrend, the price in pullbacks will often bounce off the cloud and then resume the uptrend. During a downward trend, the price will often go back to the cloud and then fall further. Therefore, the cloud offers entry into the trend.

Die Stärke der Ichimoku-Handelssignale kann anhand von drei Faktoren bewertet werden:

• Wie weit entfernt ist die Preisbewegung im Vergleich zur Cloud?
• Wie weit ist die Chiku-Spanne im Vergleich zur Cloud entfernt?
• Wie weit ist der Crossover im Vergleich zur Cloud entfernt?

Händler sollten die Ichimoku Cloud in Verbindung mit anderen technischen Trading Indikatoren nutzen, um das Risiko zu minimieren. So wird der Trading Indikator beispielsweise oft mit dem Relative Strength Index (RSI) gekoppelt, mit dem Impulse in eine bestimmte Richtung bestätigt oder widerlegt werden können. Es ist auch wichtig sich die übergeordneten Trends anzusehen, um zu sehen wie sie in die untergeordneten Trends passen.

Crossover signals

If the trend goes up (prices over cloud and span A over span B) and the conversion line falls below the baseline and then recovers above it, this signals a long start. If the trend points downwards (prices under the cloud and margin A under span B), and the conversion line accumulates above the baseline and then falls below it again, this signals a brief start.

The strength of Ichimoku trading signals can be assessed using three factors:

  • How far away is the price movement compared to the cloud?
    • How far away is the Chiku span compared to the cloud?
    • How far away is the crossover compared to the cloud?

Traders should use the Ichimoku Cloud in conjunction with other technical trading indicators to minimise risk. For example, the trading indicator is often coupled with the Relative Strength Index (RSI), which can be used to confirm or refute impulses in a certain direction. It is also important to look at the higher-level trends to see how they fit into the early trends.

7. Momentum Indicators

The Momentum Trading Indicator is perhaps the easiest to understand and use. The trading oscillator; it is the measurement of the speed valatility of price changes. In “Technical Analysis of the Financial Markets,” John J. Murphy explains this kind of indicator as:

“Market dynamics are measured by continuously taking into account price differences for a fixed time interval. To construct a 10-day impulse line, simply deduct the closing price 10 days ago from the last closing price. This positive or negative value is then drawn by a zero line.”

Momentum Indicator: Benefits for Traders

Momentum measures the rate of increase or decrease in value. From a trend point of view, this is a very useful indicator of strength or weakness. History has shown that dynamics are much more useful in rising markets than in falling markets; the fact that markets are rising more often than falling is the reason for this. In other words, bull markets tend to last longer than bear markets.

Trendlinien erkennen: unbedingt beachten

Es ist wichtig zu verstehen, dass, wenn der Momentum-Indikator unter die Nulllinie nach unten gleitet und sich dann in eine Aufwärtsrichtung umkehrt, dies nicht bedeutet, dass der Abwärtstrend beendet ist. Es bedeutet lediglich, dass sich der Abwärtstrend verlangsamt. Das Gleiche gilt für den aufgetragenen Impuls über der Nulllinie.

Momentum Trading Indicators

Traders use a timeframe of 10 days for these trading indicators to measure the momentum. You will see the zero line in the following table. If the recent closing price of the value stock, index, or foreign exchange pair, is more than the closing price 10 trading days ago, the positive number (from the equation) is represented above the zero line. If, on the other hand, the last closing price is below the closing price 10 days ago, the negative measurement is shown below the zero line.

Detecting trend lines

By measuring price differences over a period of time, we can begin to identify the prices at which the price rises or falls. Momentum helps you identify trend lines. As the share price rises, clear trend lines develop; an increasing momentum plot line above zero indicates that an uptrend is developing firmly. A signal line that is beginning to match indicates to the trader that the latest price of a value is about the same as it was 10 days ago; therefore slows down the speed of the trend.

Identifying trend lines: be sure to pay attention

It is important to understand that if the Momentum indicator slides down below the zero line and then reverses in an upward direction, this does not mean that the downtrend is finished. It just means that the downward trend is slowing down. The same applies to the applied pulse above the zero line.

8. Stochastic oscillator

The stochastic oscillator is a momentum indicator that compares the closing price of a value with the range of its prices over a period of time. The oscillator’s sensitivity to market movements can be reduced by adjusting this period or by forming a moving average of the result. The general theory that serves as the basis for this stochastic trading indicator is that in a market trending upwards, prices will close near the peak and in a downward trending market prices will close near the low. Trading signals are generated when the %K crosses a moving average (period 3) that is called %D.

History of the stochastic oscillator

The stochastic oscillator was developed by George Lane in the late 1950s. Designed by Lane, the stochastic oscillator represents the place of the closing price of a value relative to the upper and lower range of the price over a period of normally 14 days. Lane has said in numerous interviews that the stochastic oscillator does not follow prices or volume. He points out that the oscillator follows the speed or the moment of the price.

Stochastic oscillator: important trading signal

Lane also explains in interviews that the dynamics or speed of the price of a value usually change before the price changes. In this way, the stochastic oscillator can be used to anticipate inversions when the indicator reveals bullish or bearish divergences. This signal is the first and arguably the most important trading signal Lane has identified.

Stochastic oscillator

Overbought vs. oversold

Lane also expressed the important role that the stochastic oscillator can play in identifying overbought and oversold levels, as it is tied to the area. This range, from 0 to 100, remains constant, no matter how fast or slowly a value rises or falls. Given the most traditional settings for the oscillator, 20 is typically considered an oversold limit and 80 is considered an overbought limit. However, the settings are customizable. Values above 80 indicate that a value is traded near the top of its high-low range; Values below 20 indicate that the value is traded near the bottom of its high-low range.

9. ATR Indicator

The Average True Range (ATR) is a technical analysis indicator that measures volatility by breaking the entire bandwidth of a value for that period. Specifically, the Average True Range is a measure of the volatility that Welles Wilder introduced in his book “New Concepts in Technical Trading Systems”.

Trading Indicator: Average True Range

Average True Range TradersClub24

Wilder originally developed the Average True Range indicator for commodities, but the trading indicator can also be used for stocks, forex and indices. Simply put, a value that has high volatility has a higher ATR; a value that has low volatility, a lower value. The Average True Range can be used by traders to enter and exit in and/or exit trades, and it is a useful tool to extend a trading system. It was created to allow traders to more accurately measure the daily volatility of a market through simple calculations. The trading indicator does not indicate the price direction, but is mainly used to measure the volatility caused by gaps and to limit up or down movements.

Trading indicator in the chart

The Average True Range is relatively easy to calculate and requires only historical price data.

Calculation

Traders can use shorter periods to generate more trading signals, while longer periods have a higher probability of generating fewer trading signals. For example, if a short-term trader only wants to analyse the volatility of an index, such as the Dax or forex pair such as EURUSD, over a five-day period, the trader can calculate the five-day ATR (5).

The ATR indicator moves up and down when the price movements become larger or smaller. The indicator is based on price movements, so the value is a dollar amount. For example, an ATR value of 0.23 means that the average price is around .23 per price bar. On the foreign exchange market, it displays pips, with a value of 0.0025 meaning 25 pips.

Recalculation of the ATR value

A new ATR value is calculated when a time period has ended. On a one-minute chart, a new value is calculated every minute. On a daily chart, on the other hand, a new value is calculated every day. All of these metrics are recorded to a continuous line so traders can see how the volatility has changed over time.

Underlying

Underlying TradersClub24

Because the ATR is based on how much each market moves, the value for a market is not compared with other markets in isolation. For example, an ATR value of 0.50 may appear high if the share price is at ’10, but with a share price of ‘100, an ATR of 0.50 can be considered low. This is because if the price moves by 0.50 dollars to a 10-share, which corresponds to a 5 percent price movement. A movement of 0.50 dollars for a 100-share corresponds to a price change of 0.5 percent.

Average True Range as a Trailing Stop

The Average True Range is often used as Trailing Stop Loss. Look at the current ATR value at the time of trading. Place a stop loss at a multiple of the ATR. 2x is common, which means that you place a stop loss at 2 x ATR below the entry price at the purchase or 2 x ATR above the entry price on short trade.

Movement of stop loss

The stop loss moves only to reduce the risk or make a profit. If Long and the price develops positively, continue to move the stop loss to 2 x ATR below the price. The stop loss will only move up, not down. As soon as it is moved upwards, it stays there until it can be moved up again or the trade is closed because the price drops and the trailing stop is reached. In the case of short trades, the process is, of course, reversed.

Average True Range as a Trailing Stop:

For example, a long trade will be made at $10 and the ATR will be 0.10. Place a stop loss at $9.80. The price rises to $10.20 and the ATR remains at 0.10. The stop loss is now increased to 10, which is 2 x ATR below the current price. If the price rises to $10.50, the stop loss will rise to $10.30 and secure at least a profit of $0.30 from trading.

10. ADX Indicator

The ADX (Average Directional Index) is a trend strength indicator developed by J. Welles Wilder. The ADX is actually a set of technical trading indicators developed by Wilder, so some trading platforms split the trading indicators and offer Directional Movement as one indicator and ADX as others. Typically, these trading indicators are used together to form the ADX.

Calculation of the ADX indicator

The ADX is calculated from the comparison of the current price with the previous price range. DMI then returns updirection index (+DI) and downward direction index (-DI). The DMI also calculates the strength of the up or down movement and displays the result as a trend strength line called Average Directional Index or ADX.

+DI and -DI appear as two separate lines, each colored green and red. If the red line is above the green line, it means that the price drops. If the green line is above the red line, it means that the price increases. If the -DI and the +DI cross back and forth, there is probably no price trend and the price moves sideways.

ADX indicator in the chart

ADX Indikator TradersClub24

An ADX value above 25-20 indicates that there is a strong trend. When the ADX fluctuates below 25-20, it usually means that there is no strong trend and the price movement is sideways or within a weak trend. Some traders only use the ADX to see the trend strength, while others prefer to look at the directional lines to confirm the price direction.

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