So why do we need technicals? It is necessary because it provides an overview of the present scenarios and predefined laws. For example, let’s take up – Inflation. Policymakers use Consumer Price Index (CPI) as an indicator for change in inflation. This CPI Index is nothing but the technical indicator used to calculate the actual Inflation levels.
Let us know what is Technical Analysis and Technical Indicators?
Before investing in stocks, it is variedly essential to study the going trend of the prices in the market. For example, if the share price of ‘ABC’ company appears falling since last few sessions and reach the bottom.
Some may feel that this is a golden opportunity. Grab it! Its cheaper now!
But is that the actual truth? Not really. Cheap and expensive comes out of mere comparison. Suppose, let’s say, you bought at the seven-year low price. What happens the next moment/day. The share price continued to fall. So how do I know the correct entry and exit point in any kind of trade?
Is there any way out of it? Yes. There is. We need to do Technical Analysis which makes use of patterns over market data to identify trends and make predictions.
Now the next question is, how to perform Technical Analysis? We use Technical Indicators which provides a precise study of the ‘Price Trend Pattern’ of the chart.
A chart containing a few such Indicators would guide any trader to predict the future actions of the trading entity. This will ultimately help the traders to achieve more profit and take precautions against any possible price drop.
There are five popular Technical Indicators widely used among traders. One can break down these indicators into four categories for one’s convenience, such as Trend, Momentum, Volume, and Volatility.
These Significant indicators are as follows:
1) Bollinger Bands (BB):
These Bands are like channels which move according to the price range. It gives an indication about the Volatility in the Prices. BB includes the outer lines, which formulates the band. Also, it consists of a 20-days Moving Average called as Central line. This Moving Average (MA) lies in between both the upper and lower band.
Let us learn this indicator in more depth.
BB gives a hint about the Overbought and Oversold conditions, providing knowledge about the trend and also aiding at times of breakout.
The Overbought situation appears when the market is expected to correct the price in the near-term. And, when the market anticipates the prices to go down in the short-term, then it is termed as Oversold.
The most basic usage of Bollinger Bands is to indicate the trend, sideways, downtrend or an uptrend. When the price remains in the upper part of the Bollinger Bands for a while, then one can expect an uptrend. On the contrary, if the price fluctuates in the Lower Bollinger Bands consecutively, then one can expect the downtrend.
One more fascinating fact about Bollinger Bands is that the Bands expand when the price goes up and the Band contracts when the price goes down. This phenomenon of the Bollinger Bands helps to provide accurate trending evidence.
Additionally, a trader can analyze a Stop-loss level over the price from the Bollinger Bands. The trader can avoid the falling prices and set up the Stop-loss level at such a point where there are more chances of the prices to plunge. Therefore, Bollinger Bands is an added advantage to prevent traders from making a probable loss in any unexpected market events.
2) The Simple Moving Averages (SMA):
There are many types of SMAs which are used for technical analysis. The most popularly used ones are the 50 days, 100 days, and 200 days SMA. As per definition, the SMA is nothing but the arithmetic moving average. It is computed from the latest closing prices, and later it is divided by specific number of days.
An= the price of an asset at period n
n= the number of total periods
Further, in the given sample chart, these averages are plotted as red and blue coloured trend lines. The traders will need to observe the location of the pair concerning this average. When the price trend is above the Simple Moving Averages, then it is termed as a Bullish trend. It means that the prices are stronger than the average price. Therefore one can make a buy call at this point.
But you might doubt what happens if the averages take over/above the price line then what does it mean?
So the answer is when such a situation takes place, it indicates that the price has gone weaker. During such circumstances, one can expect a Bearish trend, and one should avoid buying at the moment.
Friends, this indicator has something more to tell us. So let’s dig in further!
These SMAs also help to perform the near term and long term price analysis.
For that purpose, let us consider the number of days taken in the calculation of the short term average is 50-days. Notably, when this 50-day SMA, moves or cross over the other SMAs then there is a significant improvement in the price. And, one can expect near-term prices to appear high. Whereas, in the case of long-term average, a longer period of days are considered, such as 100-days or 200-days. Now if these averages, appeared suppressing the short – term average or the 50-days SMA, then one can anticipate high prices in the long run.
Therefore, SMAs is an essential method in forecasting the long term price trend. With such type of Technical Indicator, one can plan their investments and make sure they will avoid incurring a loss in the future.
3) Relative Strength Index (RSI):
It is a popular momentum oscillator developed by J. Welles Wilder Jr. in 1978. It computes the extent of a recent price change, helping the trader to assess the trend in the price.
You might observe in the given image, that it is located in the bottom of the price chart.
Yes it is! Isn’t it fascinating as a separate scale on the chart that describes evidently about the trend. Let us study more about RSI and its benefits.
There is an Index line which is plotted on the bottom of the given price chart. One can get information from studying the pattern of the indicator. When the RSI level is above 70%, then it means ‘overbought’ situation. And, when the RSI level seems to appear below the 30%, then it signals as the prices have fallen and there is ‘oversold’ situation. Moreover, the most common use of this indicator is that it helps to analyze the Bullish or Bearish drive with the given asset’s price.
Additionally the indicator provides information about the Breakout point. This occurs when the RSI index cross & move above the 30 levels,and followed by a bounce, then one can predict a Breakout point. Therefore such a trend in the RSI will confirm price to increase in the upcoming session.
The Now, in case of downward momentum, the RSI breaches the 70 levels and travel downwards. It might occur bouncing down from 70 handles, so here is the point where one can get a hint of falling price and strong selling signals.
Summarizing the purpose of the RSI is to indicate the market about the overbought or oversold status.
4) Ichimoku Clouds (IC):
In this indicator, there are two types of clouds, one is Red cloud, and the other is the Green cloud.
So let us study in depth about these clouds so that it will tell you how this indicator helps.
The Green cloud is also termed as the Leading Span A. It is the average of the Conversion line and the Base line which we would learn laterwards. Here, one should keep in mind that,
- The Conversion line and Base line are 9-days Moving Average (MA) and 26-days MA respectively.
- The Green cloud boundary moves faster than the Red cloud boundary because of the difference in the periods.
- The IC works similarly like the moving averages, that is, the shorter moving averages are more sensitive and faster than longer moving averages.
Moving forward, when the price increases, the Green cloud appears to rise, staying overhead. Therefore, this indicates a Bullish stance over the price action, and one can be sure about having an uptrend. Green cloud also act as a support point for the price. The price candle hits this Green cloud and moves upward.
But then what’s with the Red clouds?
The Red Ichimoku clouds indicate near-by downward trend in the price movements. A Red cloud would occur hinting a price downfall. The Red cloud work as resistance point to the pair. So whenever you see Red cloud, it means there might be a Bearish trend coming up dragging the prices down.
Readers, let us come back to the Base line and the Conversion line. These are two more sub-indicators in the IC. Sometimes it is difficult to determine exact Conversion line and Base line levels on the price chart.
Therefore one can identify them through colors used in drawing these lines. A red colored denotes Base line whereas a blue colored line denotes the Conversion line.
Let us understand more about these sub-indicators. The Conversion line also called as Tenkan Sen. It is calculated using the sum of the highest and the lowest price over the last 7-8 days. The obtained sum is then divided by two.
Moving ahead with the Base line, it is also known as Kijun Sen. It signifies the near to medium-term price momentum.
How to calculate Kijun Sen?
It is computed for 26 days and the sum of the 26 period high & low levels are used.
Folks, let’s see what do the Conversion and the Base lines tell us?
When the prices are above the Base line (which medium-term period), it signifies short-term price is moving upwards. Whereas, the Conversion line due to its lesser number of days it is used only in comparison with other indicators. Therefore, when the Conversion line crosses the Base line and moves above the Kijun Sen, then it is a buy sign. And, on the reverse side, if the Conversion line falls below the Base line, then there are more chances of selling.
In a nutshell, there are four critical indicators within the Ichimoku clouds which one needs to look carefully.
5) Keltner Channel (KC):
This indicator is composed of three components, one is the Upper band, second is the Lower band, and the other is the Exponential Moving Average (EMA).
Let us first understand what the advantages of the KC?
Firstly the channels of the KC helps to identify changes in the trend and acceleration of the trend.
Secondly the direction of the KC also assists in providing more knowledge about the trend direction of the asset.
Now let us see how the components are formulated?
- The upper band equals to two times the Average True Range (ATR) above the EMA.
- And, the lower band is usually a set of two times the ATR below the EMA.
Keltner Channel Upper Band=EMA+2∗ATR
Keltner Channel Lower Band=EMA−2∗ATR
EMA= Exponential Moving Average (typically over 20 periods)
ATR= Average True Range (usually over 10 or 20 periods)
The KC benefits the traders in many ways, lets see how:
A rising channel will signify that price will continue to go up, while a falling or sideways channel would indicate price will fall or move sideways, respectively.
Moreover, it can happen that the price has moved ahead of the upper band, then in such case, it will have a bullish outlook. Whereas, if it occurs that the price is traveling below the lower band, then there are more chances of a downtrend.
Furthermore, one can get excellent predictions out of this indicator.
Suppose if the price is hitting the upper band all the time, but finally, reach the lower band then the trader can expect the trend to reverse.
And, if the price is continuously touching the lower boundary of the KC but somehow finally arrives at the upper band then, one can conclude that the downtrend will get over soon. Surprisingly, the Bands of the KC also act as a support and resistance level when the price is bouncing inside the KC.
Hopefully, the article was helpful and provided a better idea about these technical indicators. These were the most important and common Technical Indicators widely used.
James Simon, one of the top Billionaire traders of the globe, had advice nicely on how future estimation helps a human being. He has said “Everything is tested in traditional markets. The past is a pretty good predictor of the future. It’s not perfect. But human beings drive markets, and human beings don’t change their stripes overnight. So to the extent that one can understand the past, there’s a good likelihood you’ll have some insight into the future”.