Introduction:
➡Types of trading indicators
There are two types of indicators Leading and Lagging. Leading indicators already signal a change in trend. Leading indicators do not give completely accurate signals, so their signals cannot be completely trusted.
Lagging indicators give signals after the start of the trend.
Before we proceed to understand the indicators, we must understand the meaning of momentum. Momentum is the rate at which the price changes. For example if the stock price is Rs.1000 today and it goes up to Rs.1050 the next day, and up to Rs.1150 a day later, we say the momentum is high because the stock price has changed by 15% in just 3 days. If this 15% change happens in 3 months, then we would say that the momentum is low.
1.RSI (RelativeStrengthIndex):
RSI is a very popular indicator. rsi is a leading indicator which helps in identifying a trend reversal. The RSI indicator stays between 0 and 100, and based on the latest reading of this indicator, the market direction is predicted.It does not compare two stocks, but instead shows the intrinsic strength of the stock. RSI is the most popular leading indicator, which gives the strongest signals in sideways markets and during range periods in non-trending markets.
Formula to calculate RSI.
RSI = 100 – 100/1+RS
RS= average again or lose
Using the RSI helps the trader identify overbought and oversold price zones. Overbought means that the buying i.e. positive momentum in the stock is so high that it cannot sustain for long and hence there could be a correction. Similarly, an oversold position suggests that the negative momentum is high enough that a reversal is possible. You can see the example RSI below.
First of all the red line at the bottom of the price chart is showing the 14 period RSI. If you pay attention to the scale of the RSI, you will feel its upper limit is 100, and the lower limit is 0, although you will not see 100 and 0 on the chart.
When the RSI reading is between 30 and 0, the stock is oversold and should be ready for a correction. When the reading is between 70 to 100, the stock is overbought and ready for a downside correction.
The first vertical line marked on the left shows a level where the RSI is below 30, in fact the RSI is 26.8. Means RSI is suggesting that the stock is oversold. The RSI value of 26.8, in this example, is associating with a bullish engulfing pattern. This gives the trader double confirmation of going long! Needless to say, the volumes and S&R should also confirm this.
The second vertical line indicates the level where the RSI becomes 81, where it is considered overbought. Hence, the trader should be careful in his decision to buy this stock if there is no intention to short. If you then look at the candles, they appear to be forming a bearish engulfing pattern. So the combination of bearish engulfing pattern and RSI of 81 are giving signals to short the stock. After this there is a bullish and a minor correction in the stock.
The example I have shown here is quite good, meaning that both the candlestick pattern and the RSI are in perfect harmony to confirm the same event. This may not always be the case.
2. Moving Average Convergence and Divergence–MACD
MACD is considered the oldest and most important indicator. It was invented in the seventies, but momentum traders still consider the MACD to be one of the most reliable indicators.
MACD is all about convergence and divergence of two moving averages. Convergence occurs when two moving averages move towards each other, and a divergence occurs when the moving averages move away from each other.
A common MACD is calculated using the 12 day EMA and the 26 day EMA. Please note that both EMAs are based on closing price. To calculate the Convergence & Divergence CD, we subtract the 26 EMA from the 12 day EMA. A simple line graph of this is often referred to as the 'MACD line'.
When we calculate the MACD based on the 12 and 26 day EMA and plot it as a line graph, we get the MACD line, which moves above and below the central line.
The signal attached to the MACD tells the direction of the stock's movement When the MACD is negative, it means that the 12 day EMA is below the 26 day EMA. Hence the momentum is also negative. The higher the magnitude of the MACD, the stronger the negative momentum.
The difference between the two moving averages is called the MACD spread. NWhen the momentum decreases, the spread decreases and when the momentum increases, the spread increases. Traders usually plot MACD charts, often referred to as MACD lines, to look for convergence and divergence. You can see the example of macd below.
3. The Bollinger Bands.
BB is one of the most useful indicators used in technical analysis there are three Constituent of BB
1.The middle line, which is the 20-day simple moving average of the closing prices.
2. An upper band. This is +2 standard deviations from the center line.
3. A lower band - this is 2 standard deviations from the center line
Standard deviation (SD) is a statistical concept; that measures the variance of a particular variable relative to its mean. The standard deviation of a stock price shows the volatility of a stock. Here is a example of BB below.
The central black line is the 20 day SMA (SIMPLE MOVING AVERAGE). The two red lines above and below the black are +2 SD and 25D. When the stock price touches the upper band, one should short with the expectation that it will revert to the average price. Similarly, when the price touches the lower band, go long and expect it to revert to the average.
The upper and lower bands of BB together form the envelope. The expansion of the envelope occurs when the price signals strong momentum in a particular direction. The BB signal fails when there is an envelope expansion. This leads to an important conclusion that BB works well in a sideways market, and fails in a trending market.
4. Fibonacci retracement
The Fibonacci series is a sequence of numbers starting with zero that are arranged in such a way that the value of any number in the series is the sum of the previous two numbers.The Fibonacci series is as follows:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610...
Pay attention to the following:
233144+89
144 = 89 + 55
89 = 55 + 34
Means the addition of the previous two numbers makes the next number and this series goes on till infinity. The Fibonacci series has some interesting properties.
If you divide any number in the series by the previous number, the ratio will always be approximately 1.618.
Fibonacci ratios ie 61.8%, 38.2% and 23.6% can be used in stock charts. Fibonacci analysis can be applied when prices have made significant moves or lows. Whenever a stock moves sharply up or down, it usually retraces to a level before its next move. For example, if a stock moves from Rs.50 to Rs.100, it is likely to retrace to Rs.70 before it can move further to Rs.120.
The retracement level forecast' is a technique using which one can identify the level up to which a retracement can happen. It is these retracement levels that give the trader an opportunity to enter new trades looking at the direction of the trend. The Fibonacci ratios ie 61.8%, 38.2% and 23.6% help the trader to identify the possible range of retracements. The trader can use these levels to place trades. here is a example of Fibonacci retracement.
Now I would define the move up to 109 (380489) as a Fibonacci Upmove. According to the Fibonacci retracement principle, any stock that is going up in a correction can fall to the Fibonacci ratio. For example, the first correction of the stock could be up to 23.6%. If the stock corrects further, it can show 38.2% and 61.8% levels as well.