Trading indicators: harnessing the power of numbers

Financial markets can be irrational places, driven by fear and greed and then fear again. As such, it’s not always possible to pick up trends using a calm appraisal of the facts. Trading indicators can help. These are mathematical calculations that can help you judge the emotion as well as the logic in market pricing. They can be a potent weapon in a trader’s armoury.

There are as many trading indicators as there are stocks, and traders will quickly learn to understand those they trust most. Few can be used in isolation but, blended together, they can help you make better trading decisions. It is also possible to set signals to alert you to price anomalies.

Here we look at some of the more widely used indicators:

Stock analysis

When trading the shares of individual companies, there are two types of analysis that can provide clues to their future direction – fundamental and technical. Fundamental analysis looks at the underlying characteristics of the company itself: is it making a profit? Paying dividends? Does it have a giant scandal breaking on Twitter?

Technical analysis looks only at trading factors and the direction of the share price. How does the price compare to history? Are trading volumes higher than normal? Using this analysis, traders can build a picture of any patterns in a company’s share price and make decisions accordingly.

Forex analysis

Similar technical analysis can be used to trade foreign exchange (linkare all’articolo The six things that influence currency markets) (forex trading). At its simplest level, traders can see how a currency looks compared to its history – the relative strength index, for example, is a measure of whether a currency is overbought or oversold. It is also possible to look at whether a currency is above or below its long-term average against another currency. There will often be reasons for a currency’s relative weakness, but it gives traders a benchmark. The average true rating measures the price volatility of a currency pair.

Candlestick patterns

Candlestick patterns were devised by Munehisa Homma and designed to be a visual representation of the price trends of a security or currency pair. They can be a useful way to spot patterns, including volatility and sentiment.

Candlestick charts shows four data points: the day’s opening and closing price, and the day’s high and low price. The body represents the open-to-close range, while the wick shows the intra-day high and low. The colour – usually green or red – shows the direction of market movement.

Candlestick formations tend to be characterised as either bearish or bullish and will often come with wacky names – hanging man, shooting star, shaven head. They are an easy way to quickly absorb a lot of information on a stock’s current trading pattern.

Bollinger Bands®

Bollinger Bands® were developed by John Bollinger in the 1980s and measure volatility in the price of individual securities over time. These ‘bands’ are designed to provide a relative definition of high and low prices in a market, on which traders can then base decision making. For example, a trader might buy when price touches the lower band and sell at the mid-point. More volatile assets are likely to have a wider band.

Fibonacci trading

The concept of the Fibonacci sequence is straightforward – each number is the sum of the two preceding numbers, starting at 0 and 1. The ratios yielded by the sequence are found widely in nature – the petals of flowers for example, or in broccoli florets. They can also be useful for traders deciding when to place trades.

Fibonacci retracement is the most popular. This gives an indication of where support and resistance points are likely to be for different securities. They can be applied to almost any security and can help traders know the level at which to place stop-loss orders and set target prices.

Harmonic scanner

A harmonic scanner is a software tool that checks price charts for harmonic patterns, which are changes in price direction that follow the Fibonacci sequence. Again, recurrent patterns are given unusual names - the Gartley, the crab, or the bat. A harmonic scanner can alert traders to specific patterns in order to make trading decisions.

MACD indicator

MACD stands for Moving Average Convergence/Divergence. This is used to measure the strength and durability of trends in securities prices. Traders use it in combination with other technical indicators to determine inflection points in the market.

Technical indicators can help traders make better decisions. They are a means to judge the sentiment of the market in a numerical way. Fineco has a range of learning webinars to help you use technical indicators to improve your trading, with guidance from experienced traders who know the ropes.