What are trading indicators and how can they be used
Trading indicators are a set of tools that can be applied to a trading chart, giving a trader a clearer view of the market whilst allowing his trading decisions to be more accurate. An Indicator is handy as it can provide specific market information, such as whether the asset price is likely to change in direction or if it is being overbought or oversold.
These can be displayed on the price chart, such as with moving averages, channels, or Bollinger bands, or under the chart, like with the stochastics or the MACD.
Even though different indicators can be used for different purposes, they can be divided into two categories:
Leading - used to provide a signal ahead of time, measuring the rate of change of the price action, and signalling whether it's slowing down or speeding up. For example, if a price that has risen quickly suddenly slows down or stagnates, an indicator could suggest a change in momentum and signal a reversal;
Lagging - where the signal or information is given after the price action and is usually used to confirm this price action, indicating whether a trend has started and its strength. This can usually be used to locate good entry or exit points for trades.
Furthermore, an additional distinction can be made between types of indicators, depending on how the indicator was calculated in the price action in order to provide the signal.
Trending indicators - usually lagging by nature, are used to identify whether the market is in a trend, and the strength of the trend, and help provide entry and exit prices in and out of the market.
Oscillating indicators - tend to be leading, and provide information about whether an asset is being overbought or oversold. When prices are oscillating in a range, this type of indicator helps determine the upper and lower boundaries of the range.
Examples of when to use trending and oscillating indicators
As many indicators are available, traders have the option of choosing which ones best suit their needs and trading strategy. As mentioned above, oscillating indicators are particularly useful in ranging markets, while trending ones are more useful in trending markets.
In this example, we can see both trending and oscillating indicators being used, with a typical trending indicator (in purple), the moving average convergence/divergence (MACD), and a classic oscillating indicator (in orange), the Stochastic Relative Strength Index (RSI), being displayed on the graph.
In the case of the MACD, we can notice how when the two moving average lines cross, there is a change in trend, signaling to a trader to close his position, in case of a long, or to open a position in case of a short. Similarly, the opposite can be seen with the second purple arrow, where the blue line crosses over the orange, signaling to the trader to buy as there might be a good entry point.
On the other hand, in the case of the Stochastic RSI, we can see with the first orange arrow a crossing, which suggests that the trend might have exhausted and might be due to a reversal. In fact, a few candles later we can see the trend reverse and prices fall lower. Similarly, the opposite can be noticed with the second arrow, where a downtrend is ready to reverse and prices to move upwards. These indicators don’t always give an accurate reading on how the trend will change but rather that there will be a change.
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