Technical Indicators: What Are They and How to Use Them?
In one of our previous articles, we delved into the fundamentals of technical analysis, exploring its core concepts and techniques. This time, however, we aim to concentrate specifically on the subject of technical indicators, an integral component of market analysis. As part of our new blog series, we plan to thoroughly examine these indicators, offering a comprehensive understanding of their purpose, functionality, and practical applications. We will discuss the various types of technical indicators available to traders and investors, as well as the key insights they provide in terms of price movements, trends, and market sentiment. Additionally, we will share tips and strategies on how to effectively utilize these tools in order to enhance trading decisions and maximize potential profits. Stay tuned as we embark on this informative journey, shedding light on the intricacies of technical indicators and their role in successful trading.
What Are The Indicators?
First, it's important to explore what the term "technical indicator" encompasses. Technical indicators are often used in technical analysis, along with identifying support, resistance, and chart patterns within currency pairs. Indicators are calculated based on statistical and mathematical computations, such as a currency pair's closing prices or their averages, using specific formulas or equations. Nowadays, advanced software can automatically calculate and apply these indicators to a currency pair's chart.
To use and recognize the signals of indicators, it's not strictly necessary to know these equations, although understanding them may help gain a deeper understanding. This decision is entirely up to investors, but it's important to emphasize that many indicators involve complex calculations, so it may not be necessary to know every single one.
The Importance of Indicators
It is an important human nature to try to recognize trends in our environment, make decisions based on them, and predict certain future events. However, it is important to mention that in financial markets, past events fundamentally do not have a dramatic impact on future movements, or not to the extent and in the way we first think. The market prices the future, at least theoretically.
Nevertheless, technical analysis cannot be considered useless because it is not at all irrelevant when we buy a particular financial instrument, and even if a company looks good based on fundamentals, the price may show a clearly declining trend. Therefore, in the short term, it can be particularly useful to examine an instrument from a technical perspective before investing.
In interpreting the technical picture, indicators can help investors a lot. In general, they can facilitate the identification of a trend or trend reversal, and their advantage is that they show objective values, thus helping to draw a less subjective conclusion. Of course, it is up to investors how they interpret the technical picture, but indicators can still help to form a more objective opinion, as the past data from which the displayed values are calculated are already given.
Types of Indicators
Indicators can be divided into several groups. Technical indicators can be divided into groups based on the inputs they work with and the situations in which they can be used. Based on this, we can distinguish the following types:
Furthermore, based on signal delay, we can distinguish two different groups of indicators. An indicator can be forward-looking (leading) or lagging. The difference between the two is that forward-looking indicators signal before or at the same time as market processes, while their lagging counterparts generally send signals after a trend reversal. Both groups have their advantages and disadvantages, typically lagging indicators signal with a phase delay, so investors may miss a possible trading opportunity. However, their advantage is that their signals are usually more reliable than those of forward-looking indicators.
- Trend
- Momentum
- Volatility
- Volume
Furthermore, based on signal delay, we can distinguish two different groups of indicators. An indicator can be forward-looking (leading) or lagging. The difference between the two is that forward-looking indicators signal before or at the same time as market processes, while their lagging counterparts generally send signals after a trend reversal. Both groups have their advantages and disadvantages, typically lagging indicators signal with a phase delay, so investors may miss a possible trading opportunity. However, their advantage is that their signals are usually more reliable than those of forward-looking indicators.
In later articles, we will present in more detail the popular indicators belonging to the different groups. For now, we will briefly introduce these groups.
Trend indicators
This group of indicators helps determine the trend of the price movement: whether it is rising, falling, or moving sideways. The most popular and simplest trend indicator is the moving average and its various versions, which is also widely used in statistics. The MACD (Moving Average Convergence Divergence) also belongs to this group. In the next section, we will discuss in detail the different types of moving averages and when to use them. Trend indicators primarily work with averages, so they tend to give lagging signals.
Momentum indicators
The next group aims to predict the momentum of the price movement, i.e., the rate of rise or fall. The value of these indicators is derived from the difference between current and previous closing prices, so they usually give forward-looking signals. This group includes the RSI (Relative Strength Index) and the stochastic oscillator, which we also use frequently in our analyses.
Volatility indicators
Investors are interested not only in the current trend and momentum of a security but also in its volatility. Changes in volatility can signal the start of a trend after a consolidation period, or we can use the values indicated by the indicators to adjust a stop-loss level. This group includes the ATR (Average True Range) and the popular Bollinger Bands. Volatility indicators usually give lagging signals.
Volume indicators
Less popular than their counterparts listed above, but there is also a fourth group of technical indicators that monitor changes in trading volume. Increasing trading volume can confirm a rising momentum, and typically, trading volume is higher at price peaks and bottoms, making these indicators useful for identifying trend reversals. In addition, we can track the movement of "smart" money through these indicators, allowing us to identify false upward trends.
Other indicators
Not all indicators can be categorized into the above groups. There are also more complex indicators that use both forward-looking and lagging indicators simultaneously. The Ichimoku cloud is one such example, which we will discuss in more detail later.
Using Indicators in Forex Trading
When trading Forex, using indicators for technical analysis or timing trades can be highly beneficial. However, it's important to remember that focusing on a few indicators and their signals for each currency pair is more effective than trying to follow too many signals at once. This is because trying to keep track of too many signals can lead to confusion, and not all signals are likely to coincide.
It's also crucial to keep in mind that indicators alone do not provide a complete picture. Forex traders must consider other factors, such as market sentiment, fundamental analysis, and news events, when interpreting the technical picture. Relying solely on indicators is not advisable.
It's essential to find the best indicators for your trading style, as what works for one trader may not work for another. Similarly, strategies based on certain indicators may work well for some currency pairs but not for others.
In this article, we do not aim to establish a ranking among indicators. Instead, we aim to provide an overview of some popular indicators and how they can be useful in certain situations. Traders should focus on finding the right indicators and combining them with other forms of analysis to make informed trading decisions.