An investor who aspires to become successful must possess two types of skills and learn how to apply them well – fundamental and technical analysis. They are very distinct skills from each other, but it will be hard to comprehend the issues involved in your stocks without learning both. The best investors in the history of stock investment have used analyses based on technical indicators to get projections of the demand and supply of securities or related market psychology. Stock market indicators, market operators, and other related metrics of trades should be looked at almost before any specific trades are undertaken. One such metric is the trading volume, which can provide excess information that can impact future trades positively.
Fundamental analysis is, at the core, taking a closer look at the financials of a certain company. In that regard, fundamental analysts lift all stones in search of anything that can impact the worth of a given company. This may involve both external stakeholders such as the economic environment and managers’ internal control and strategic management considerations.
Technical indicators, or technical, are those which do not concern themselves with any aspect of the underlying business such as earnings or revenues or profit margins. For example, a long-term investor may want to use technicals in the most productive way possible by looking for the best time to buy or sell the stock, therefore analyzing the long-term trend.
What is meant by the term ‘Technical Indicator’ and what is Technical Analysis
In the analysis of stocks it is applied, a technical indicator refers to a statistical measure of the past price or volume (or, in the case of futures contracts, open interest) data of the market with the aim of predicting the direction of the financial market. Technical indicators play a major role in gauging market disequilibrium and such indicators are usually fitted with a graph for market trend prediction. Indicators usually sit on the price chart on the data and signal red alert where the price is headed, or the price level whether it is ‘overbought’ or ‘oversold’ regions.
Traders who apply technical analysis in their day to day trading practices are called chartists and they tend to have different tools such as indicators, oscillators, and patterns to obtain signals. Over time many technical indicators have been created by traders and many more continue to be created in a bid to improve performance. New technical indicators are often back tested on historic price and volume data to see how effective they would have been to predict future events. Technical indicators seek to forecast the future level of prices or the price trend of interest of the security based on the past behavior of the security. There are also momentum indicators that technical analysis tools employ, and most technical analysis is done with many tools used together rather than a single indicator. Of course, you may not need all of them, but you can choose the one which is most optimal for the particular trading strategy, say the most optimal one for intraday trading.
There are dozens of indicators that can be displayed on the charts, but here is an outline of the most important technical indicators to know.
Accumulation/Distribution Line
The accumulation/distribution line (A/D line) is a to figure out the inflow or outflow of investors into or out of a security. A better assessment could be made when the A/D Line is sloping above the previous one as it means that new money is coming into the security. The contrary is true when the slope is headed downwards. In most of the cases this indicator runs pretty much to the movement of the stock itself but tends to advance a little bit before the security and helps to ascertain whether a near term rally or a sell off is in the offing.
MACD – Moving Average Convergence/Divergence
The stock market contains a considerable number of indicators and one of the most popular technical indicators is probably the Moving-Average Convergence/Divergence line or MACD. It is mainly used to show the direction the market price has taken as well as the circulating power of the stock. The MACD line is used to analyze the differences in the state of the stock for both short and long ranges and predict its performance in the coming days. In plain terms, it is the difference between two moving averages at any time these can be set anywhere from days to weeks months etc. Most commonly the 12-day and 26-day moving average of the stock is applied.
The cross of the two lines implies the change in the future behavior of the stock exchange. And when it does, and the horizontal penetration occurs below the longer line, the stock will normally go up in anticipation of the stock price. The opposite cross gives the signals to expect the fall of the stock price.
Head and Shoulders Pattern
When a stock rises to a peak to form the first “shoulder” and then falls, the head and shoulders chart pattern occurs. It then rises over the earlier peak to create the “head” and drops beneath the first shoulder before rising to the level of the first shoulder and falling, forming the second shoulder.
As a trend reverser, most technical analysts view a head and shoulders as a prospective pattern. Such development in the price action of one of your stock holdings could be an early indication of the onset of strong selling pressure.
Also included in the technical analysis of stocks, the head and shoulders pattern is said to develop when the price of any stock moves upwards to a high and then retraces back to the low of the previous range. Next, you will see the price of the stock moves above the last peak and creates a nose which is called the head. Prices will then recede back to their previous level and later rise again to the level of the first peak. This pattern is normally observed before or during transition from a bullish trend to a bearish trend.
Gaps
Gaps are present when the opening price of a stock is either far too up or down as compared to the closing price of the previous day. Some market fundamentals could have been in effect prior to market opening which accounts for the said difference. This might lead to significant action in the stock during after hours, in which case this vector resumes at this point once the normal trading day resumes. Gaps are critical as they introduce new support and resistance levels to the asset. These points serve as a stop loss or limit beyond which investors plot sell orders.
Common gaps, however, are not arranged in price pattern apace. They merely indicate a section of the price chart where stocks have gapped. Mid-formation of a price pattern, there exists emergence of continuation gaps (runaway gaps). Buyers and sellers who believe in the same future direction of an underlying stock are likely to exhibit such behavior. Simply put, gaps are price ranges that have no trading activity within them.
Double Tops or Bottoms
This chart pattern also announces global trend reversals. Finding this chart pattern is quite simple. For example, in a double top, the stock prices two times approach a certain price level disequilibrium, and in each case the stock is resisted. Conversely, a double bottom occurs when a stock falls to a price and does not move below this price level. While a double top shows the imminent onset of selling pressure and a double bottom suggests the stock is set to move to a higher price.
Are Indicators in the Stock Market Helpful?
The inquiry that usually circumnavigates in the minds of many traders is; are the measures in place as regards the technical indicators and fundamental analysis of any relevance to the market? For instance, in technical analysis, the market is analyzed through the use of trading patterns on graphs and their specific movements only. A range of empirical research has supported the effectiveness of technical analysis, but many investors still rely on their “gut.” The categorical existence of technical indicators and their precision, is as of today still open The use of it should, however, allow you to sort out objectives. To make the right investment choices, one should combine it with fundamental analysis.
Know your Technical Indicator
Traders who participate actively in the market are the heaviest users of technical indicators since these tools are mostly for short-term price fluctuations analysis. For a long-term investor, however, whatever technical indicators that can be used are not useful for the most part (but some may be) because they do not provide insight into the business being invested into. Depending upon the trading strategy that you adopt and the kinds of trades that you would like to undertake, there are specific indicators that are more geared towards helping you. For example, the most useful indicator in trading options could be one that is of no relevance to a day trading strategy but rather to one using the Relative Strength Index or Bollinger Bands.