Indicators are tools at disposal of technical analysts

Indicators are tools at the disposal of technical analysts to help them understand, interpret, predict, alert, and/or confirm the moves in the markets or individual stocks.

There are a number of indicators in the markets, which investors can use either singularly or in combination. Just be advised, "Too many cooks spoil the broth."

Similarly, using too many indicators, however, can confuse you instead of giving you a clear direction since there may be conflicting signals from different indicators.

There are basically three types of indicators.

a. Leading Indicators: These are indicators that lead the price move. In other words, the indicators move first and the price move follows. They usually help identify the overbought and the oversold position.

b. Lagging Indicators: The price of the stock moves first and the indicators follow. They help in identifying trend continuation or trend reversal.

c. Coincident Indicators: The coincident indicators occur almost simultaneously with the event that they signify. Such indicators are not of much use for predicting future trends for stocks.

Indicators

Moving averages:

Although it is the simplest of all indicators, analysts across the world swear by the efficacy of this tool in predicting the future movement of a stock or the markets. Moving averages help in calculating the average price of a security over a given time period.

a. Simple Moving Average (SMA) : Moving averages are lagging indicators. It is simply an average of the closing prices of a stock for a given number of days, that is, the sum of the closing price for each day divided by the number of days.

b.Weighted Moving Average: Here, weights are attached to the closing price. The common weights used are 1 for day one, 2 for day two, 3 for day three, and so on. To calculate the weighted average, first the closing price for each day needs to be multiplied by its weight.

Over a medium to long-term time period, Simple Moving Averages have proved to be much more effective than Weighted Moving Averages, when it comes to predicting upward or downward trend. And, hence, you would find most analysts using SMA more than anything else.

Interpretation

a. Trend: If a stock price is trading above the moving average level, it signals ‘bullishness’ and if the price is trading below the moving average level, it suggests ‘bearishness’.

b. Support and Resistance: The moving average also gives us support and resistance. Hence, if a stock is trading above the moving average, it will find support at the moving average level and resume its uptrend. Whereas, if a stock is trading below the moving average, it will find resistance at the moving average level and continue to fall.

c. Penetration: Thirdly, if a rising stock moving above the moving average were to start falling and go below the moving average level, then it would indicate penetration of the support (downward penetration) and signal a trend reversal.

Similarly, if a falling stock were to start rising and move above the moving average level, it would indicate penetration of the resistance (upward penetration) and, hence, signal a change in trend.

Arms Index or Trading Index (TRIN)

A short-term technical analysis breadth indicator determines the buying and selling pressure in the market and the general breadth of the market. Basically, it is a comparison between the volume of advancing stocks and the volume of declining stocks and its strength.

Interpretation

An index of greater than 1 means that the average volume of stocks that fell is greater than the average volume of stocks that rose and conversely if the index is less than 1, it means that the average volume of stocks that rose is greater than the average volume of stocks that fell.

Generally, a TRIN value below 1 is considered a bullish sign whereas a TRIN value of greater than 1 is considered a bearish sign.

Readings above 1.5 or below 0.5 are considered extremely bearish or extremely bullish, respectively.

Tick Index

It is the simplest short-term indicator but it has a sizeable chunk of loyal followers. Often this index is useful for only a couple of minutes and, hence, is most popular among day traders to view the overall market sentiment at a given point in time. It compares the number of upticks to the number of downticks in the markets at a single point in time.

Uptick: Each stock whose last trade is done at a price higher than its previous price should be marked as an Uptick.

Downtick: Each stock whose last trade is done at a price lower than its previous price should be marked as a Downtick.

TICK = number of stocks trading with an uptick - number of stocks trading with a downtick

Tick Index = All upticks - All downticks.

Interpretation

Any reading above +100 is considered a bullish sign and any reading below – 100 is considered as a bearish sign.

RSI (Relative Strength Index)

The RSI is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine the overbought and oversold conditions of an asset. It was developed by Wells Wilder. It basically helps to determine the technical strength and weakness in a particular stock by comparing the days a stock closes up versus the days it closes down. Most people use 5-day, 7-day, 9-day, or 14-day period for calculating the RSI. RSI is a leading indicator.

Interpretation

If the RSI range is from 1 to 100, RSI above 70 is considered overbought and RSI below 30 is considered oversold. If a stock is moving down but the RSI is rising or if a stock is moving up but the RSI is falling, it signals divergence and it means that a trend reversal is on the cards.

Pivot Point

A technical indicator used to determine the overall trend of the market for the next trading day based on today’s price action. On the subsequent day, trading above the pivot point is thought to indicate a bullish sentiment, while trading below the pivot point indicates a bearish sentiment. It also helps to calculate support and resistance levels for the next trading day.

Once you master this indicator you too can give support and resistance levels for a stock or an index.

Basically you need three things to calculate the Pivot Point (P) and the support and resistance of a stock: Previous day’s High, Low, and Closing Price.

Interpretation

If the stock opens above the pivot point on the next trading day, then the trading bias is upwards. If the stock opens below the pivot point, then the trading bias is downwards. R1 and S1 is the first Resistance and Support level, from where the price can reverse. If the market is near R2 or S2, it suggests that it is in the overbought or oversold zone respectively and a reversal is likely.

Remember

The purpose of an indicator is to indicate. Investors/traders should not rely solely on indicators to guide their trade. Indicators should be studied in conjunction with other analytical tools such as Fundamental and Technical analysis and when all signals point in the same direction, one can trade with confidence.