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Published On: Sat, Dec 29th, 2012

Technical Analysis: Indicator Tools

Now that we understand some of the critical features of price movements that can be seen in technical analysis (rallies from support levels, declines from resistance levels, uptrends, downtrends, and breakouts), we will look at additional methods for determining the validity of each of these occurrences.  To do this, we will look at charting tools called indicators and oscillators, which are essentially mathematical calculations that allow us to view price activity in a more objective way.

At this stage in the evolution of spread betting platform technology, all reputable brokers offer free charting packages that allow traders to attach indicators to the price activity of each tradable asset, assisting with the identification of trading setups.  Since there are hundreds of available indicators, it can seem overwhelming when you are faced with the task of choosing one or two to use regularly.  Luckily, interpreting the data and signals is a relatively easy task and here we will look at the main types of indicators used by spread betters today.

Three Main Indicator Types

Ultimately, the hundreds of available indicator types can be broken down into three main categories:  Trend indicators, Momentum indicators, and Volatility Indicators.  Each of these indicators can be useful in different types of market situations (depending on the general conditions seen in the market).

Additionally, indicators found in each of these categories are well-suited for presenting signals for different types of trading styles.  For example, if your strategy relies heavily on identifying trend direction, you would want to have a trend indicator somewhere on your trading platform at all times.  Here we will look at how these various indicator types can present trading signals in active markets.

Trend Indicators

Trend indicators, as the name suggests, are used to identify the direction and strength of a potential trend.  There are many trend indicators that are widely used, some of the most popular choices include the MACD, Parabolic SAR and Moving Averages.  Since most technical traders have at least one or two Moving Averages on their charts, we will look at a trading example using this trend indicator in the chart below:

In the chart above, we can see that prices break above the 100 Day Moving Average.  This would have been a bullish signal, suitable for buy positions in the asset.  As we can see, one prices broke above this level, retraced slightly and then bounced off of the Moving Average once again, en route to a longer term rally.  This initial trading signal could have been seen at the green arrow, and this is when trades could have been placed.

Momentum Indicators

The next indicator type we will look at is the Momentum indicator, which can be used to calculate the strength and speed of a price movement.  These indicators can be used to verify trends (if strong momentum is seen during a trend) or to signal trend reversal (if, for example, momentum is starting to decline in a previously established trend).  Examples of Momentum indicators include Stochastics, CCI,  and the Relative Strength Index (RSI).  Below is a trading example of the most common momentum indicator, the RSI:

In the example above, the RSI reading drops below 30, which is deemed to be “oversold territory” for the indicator.  This essentially means that prices have become too cheap and are likely to rise in the future.  Trade signals occur at the green arrows and prices later rally in line with the original long trade entry.  It should be noted, that in a bearish case, the indicator reading would have risen above 70, which is “overbought territory” and a bearish trading signal.

Volatility Indicators

The last major indicator type is the Volatility Indicator, which measures changes in price volatility (an early precursor of later price changes).  Examples of volatility Indicators include Bollinger Bands, Average True Range, and Moving Average Envelopes.  Here, we will look at a trading example using Bollinger Bands:

In this example, prices reach the lower Bollinger Band, signalling that volatility has become extreme and is likely to reverse.  The trading signal comes at the green arrow, and prices quickly rally in response.  Alternatively, a bearish signal would have been generated if prices reach the upper Bollinger Band.

Conclusion

Trading indicators can be a powerful tool for identifying spread betting position setups.  The great thing about all of these indicators is that they are so objective in nature and are much less affected by subjectivity and human error.  Additionally, it should be noted that trading indicators can be used in combination with one another, and when trading signals are presented in agreement, trading probabilities increase, enhancing the potential for successful trades

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.

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