Indicators are graphic elements obtained from mathematical and statistical calculations, which aim to help identify trends, measure market strength and as a trigger for buy and sell signals.
They are defined as trackers and oscillators. The trackers aim to signal the occurrence or divergence in relation to the price trend. Among the main trackers, the most common are Moving Averages and Bollinger Bands. The oscillators, on the other hand, aim to signal possible reversal points of the upward or downward movements. The most used indicators in this category are: Relative Strength Index (RSI) and Stochastic.
Created in the 1980s by John Bollinger, the Bollinger Bands represent an indicator for measuring market volatility and consist of three lines. The main one being an Arithmetic Moving Average of 20 periods and two others spaced at 2 standard deviations from the central line, forming the upper band and the lower band. The choice of the 2 standard deviations is a suggestion by John and has 95% statistical coverage of the set of prices within the defined periodicity.
One of the main functions of bollinger bands is to predict high volatility movements. When the market is “quiet”, with low oscillation, the bands contract, reducing the distance between them. The expansion of the extreme lines shows an increase in the “noise” of the market and great volatility can be expected.
The bands can also be used as dynamic support and resistance. Its better used in time of flat market.
Moving average convergence divergence – MACD
The MACD is an indicator created in the 60s by Gerald Appel and represents the difference between the exponential moving averages of 12 and 26 periods.
In order to make intersections feasible, Appel defined a slower line, which consists of the exponential moving average of 9 periods of the MACD line, denominating it the signal or trigger line. The buy signal occurs when the fastest line, in this case MACD, crosses the signal line, slower, from bottom to top. On the other hand, a sell signal occurs when the MACD line crosses the Sign line from top to bottom.
The MACD histogram represents the distance between the MACD Line and the Signal Line, being positive when the MACD Line is above the signal line and negative when it is below.
In the chart below, the MACD line crosses the signal line from bottom to top, allowing the buy entry moments before the continuous bullish movement.
Relative Strength Index – RSI
The Relative Strength Index – IFR, is considered, together with Moving Averages, the most used indicator by technical analysts and provides a measure of the strength of buyers and sellers. The RSI can be used both in trends and in consolidations.
RSI is widely used to measure the strength of a movement. This technique is based on the divergences presented between the price movement and the movement of the RSI line. In the chart below, prices are in an upward trend and the RSI line shows a downward movement. This divergence shows that the upward movement is weakened and traders can look for additional information to enter the market with sell orders. Still in the example below, just after the divergence, prices started a long downward movement.
Overbought and Oversold
As an oscillator, the RSI allows determining the overbought and oversold conditions of an asset. The levels of 70% are considered overbought, while the lines of 30% are oversold. That is, if the RSI crosses the 70 line from top to bottom, the asset is overbought, so the signal is for sell entry. On the other hand, the indicator crossing the 30 line from bottom to top, means that the asset is oversold, so the signal for long entry.
In the graph below, prices are flat allowing the use of the RSI overbought and oversold signal.
The stochastic oscillator was created by the American George C. Lane in the 1950s and is one of the main technical indicators used in graphical analysis. Lane proposed that its use is linked to the speed of the price moment.
The buy and sell signal occurs when the% K and% D lines crosses. If the% K line crosses the% D line from bottom to top, the signal is for long entry. The short signal occurs when the% K line crosses the% D slow line from top to bottom. As the stochastic ranges from 0 to 100 points, we say that the traded asset is overbought when the% K and% D lines are above 80 indicating a sell signal, and oversold when the stochastic lines are below 20, indicating a buy signal .
In the graph below, several signs of long and short entry occurring with the crossing of the lines of the stochastic.