There are three main types of technical indicators– trend indicators, momentum indicators, and volume indicators.
Trend indicators help you identify the prevailing trend in the market. They include moving averages, MACDs, and Bollinger bands. Moving averages are simply the average price of a security over a given period. MACDs are calculated by taking the difference between two moving averages and plotting it as a line graph. Bollinger bands are created by taking a moving average and then adding and subtracting standard deviations from it.
Momentum indicators measure how strong a stock’s current movement is. They include RSI, stochastic, and Williams %R. RSI stands for Relative Strength Index and is calculated by dividing the current price of a security by the average of its prices over a given period. Stochastic is calculated by taking the current price of a security divided by the range of its prices over a given time.
Volume indicators measure how much volume is traded in a security. They include on-balance volume, Chaikin Money Flow, and Accumulation/Distribution. On-balance volume is calculated by adding the total number of shares bought and sold for a given security and dividing it by the average number of shares traded each day.
Benefits of Using Technical Indicators
Determine the Prevailing Trend in the Market:
Technical indicators can help you identify the prevailing trend in the market. This is important because you want to trade with the trend and not against it.
Time Your Entries and Exits:
Technical indicators can help you time your entries and exits. For example, if you are looking at a long-term chart, you may want to wait for a bullish crossover before buying a stock.
Confirm Price Movements:
Technical indicators can help confirm price movements. For example, if the price of a stock increases and the volume increases, that is confirmation that the move is real.
Set Up Trade Alerts:
You can set up trade alerts with technical indicators. For example, you can set up an alert to notify you when a stock price crosses above its 200-day moving average.
Drawbacks of Technical Indicators
Lag:
One of the main drawbacks of technical indicators is that they lag. This means they are based on past data and may not be timely enough for active traders.
Incorrect Interpretation:
Another drawback of technical indicators is that they can be incorrectly interpreted. For example, a bullish crossover does not always mean that the stock will go up.
Too Many Indicators:
Some traders try to use too many indicators, leading to confusion. Therefore, it is important to only use a few indicators that you are comfortable with and complement each other.
Technical indicators are just one tool you can use to make trading decisions. However, it is important to remember that they are not perfect and that you should always do your research before making any investment decisions.