INDICATORS AND OSCILLATORS
Indicators are tools of technical analysis that provide a way to analyse the price movements in the stock market. They tend to generate secondary perspective to price actions by analysing money flow, trends, volatility and more, thereby helping traders to make efficient decisions by confirming the quality of chart patterns.
There are two types of indicators:
- Leading Indicators
To put simply, Leading indicators lead price movements and help in predicting the future. These indicators help in identifying breakouts or breakdowns and hence are beneficial during sideways or non-trending price movements.
Benefits and drawbacks of Leading Indicators
Leading indicators are favorable as they provide more and early signals for entry or exit to traders. These signals can act as a warning for a weakness or prediction for a strength, hence due to signals, leading indicators are helpful in the trading market.
With more and early signals, the chance of false signals also increases. False signals can lead the traders to losses that could have been ignored without the false signals.
- Lagging Indicators
Lagging indicators tend to follow price movements and act as a confirmation tool. These indicators are often used in trending periods to anticipate whether a trend is still in place or weakening.
Benefits and drawbacks of Lagging Indicators
One benefit of these indicators is that they are capable of catching a move and remaining in a move. Lagging indicators can be profitable and easy to use as the longer the trend, these indicators tend to provide fewer signals and fewer signals lead to less trading.
A drawback of these indicators is that signals may get late. Late signals lead to late entry and exit which eventually increase the risk chances.
Indicators can further be divided into two categories:
Oscillators tend to be the most common type of technical indicator used. They fluctuate above and below a centerline or between set levels as the value changes over time andare bound within a range. For instance, an oscillator may have a low of 0 and a high of 100 where zero indicates oversold conditions and 100 indicates overbought conditions. There are many types of oscillators but to begin with, they are broken down into two types:
- CenteredOscillators– These oscillators tend to fluctuate above and below a central line or a point. These indicators are helpful in recognizing the strength and weakness or direction of a security. When a centered oscillator is trading above its centerline then momentum is positive, that is, bullish and it is said to be negative, that is, bearish when centered oscillator is trading below the center line.
One example of a centered oscillator is MACD, which fluctuates above and below zero. It is the difference between the 12-day EMA and 26-day EMA of security. MACD is known to be a unique oscillator as it has both lagging elements and leading elements. Moving averages are lagging indicators and would be categorized as trend-following or lagging elements. However, MACD also assimilates aspects of leading indicators when the differences in moving averages are taken. A rate of change is the difference between the moving averages and by measuring the rate of change, MACD becomes a leading indicator. Thus with the combination of moving averages and rate of change, MACD serves as both leading and lagging indicators.
- Banded oscillators- These oscillators fluctuate above and below two bands that denote extreme price levels. The lower band indicates oversold readings and the upper band indicates overbought readings. These set bands are based on the oscillator and help users to easily interpret overbought and oversold conditions as these change little from security to security. Examples of Banded oscillators are The Relative Strength Index (RSI) and Stochastic Oscillator.
Non-bounded indicators are less common, but still, provide buy and sell signals. Also, they help in showing strength or weaknesses in trends. These indicators generate these signals in many ways but without the use of a set range.
Indicators create buy and sell signals through crossovers or divergence. Crossovers are the most approved technique used wherein the price moves through a moving average or when two moving averages crossover.
Divergence happens when the direction of a price trend and the direction of an indicator move in opposite directions, which implies that the direction of the price trend is weakening.
Indicators tend to be helpful in identifying momentum, trends, volatility, and various other strands of a security. However, this is true that indicators, when compiled with other forms and tools of technical analysis, prove to be the best and provide maximum benefit.