Indicators

Indicators
Because all transactions are recorded it is possible to take this information and
create formulas that give the chartist a different perspective on what is happening
between the relationships of time, price, and quantity.
These formulas are called ‘indicators’. An indicator is precisely what the term
implies: an indication changes to trend, price patterns, volume, etc. Indicators are
not precision tools however and must be used with judgment and consideration of
what is going on elsewhere in the market.
In order to create an indicator, the writer must use at least 2 pieces of market
data. Since all data is recorded, applying the formula to the data is simple and
provides an accurate line or histogram for more sophisticated analysis of the data.
A moving average for instance, smooths PRICE with TIME to create a line
trend indicator that is much smoother than pure price action and tells the chartist
whether or not the trend is still intact. Volume can also be changed from a histogram
to a line indicator.
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The Anatomy of a Stock Chart
Most indicators are based on PRICE and TIME. Some are based on
QUANTITY and TIME. Less common are indicators that use all 3 pieces of data,
PRICE, TIME and QUANTITY but these indicators tend to be the most reliable
of all. Such indicators tend to ‘lead’ price, meaning the indicator moves or changes
its pattern before price changes.
Setting up your indicator tool kit
For the best chart analysis, use a group of indicators based on your trading style
and the current Market Condition. Common indicator types include:
1. Trend, direction of trend, and strength of trend indicators.
2. Oscillator Indicators for Overbought and oversold which expose weakening
sideways action before price breaks out of the sideways trend.
3. Accumulation and Distribution indicators which expose the buying and
selling habits of large lot institutional investors and institutional traders.
Each leaves a different ‘footprint’ on the chart.
4. Convergences and divergences of price or volume, indicating a change of
trend direction.
5. Compression or expansion of patterns of price and/or volume in cyclical
patterns.
Addtional Considerations
Traders and investors need to use the appropriate indicators and not assume a
popular indicator will work for their trading or investing goals. Never use just one
indicator for your analysis. Try to include at least 3 and preferably 5.
Be sure that if you are trading short term that you use leading indicators rather
than lagging indicators. Leading indicators “signal” a change of price before it
actually happens. Leading indicators use all 3 pieces of data or are a combination
indicator that uses all 3 data streams in the analysis. In contrast, Moving Averages,
by their very nature, are lagging indicators and are best suited for longer term
analysis.
There are 6 primary Market Conditions. Each requires a different set of
indicators for optimal trading profits. As an example: during a platform market,
Bollinger Bands, RSI combination indicator, and Volume Accumulation with Price
Accumulation indicators are ideal. Trending indicators fail dismally.
Be sure you understand which indicator works for each market condition and
use the appropriate indicators as market conditions change. Another example:
MACD is a price/time indicator that works ideally in a trending or velocity market.
It performs poorly in platform market conditions. Stochastic works best in trading
range markets but fails during velocity trending markets because it signals an exit
just as a stock starts a velocity run. As the market shifts from one condition to the
next, change the indicators you are using so that your analysis is correct.
Summary: Chart analysis is a necessary skill for anyone who has money in the
financial markets. Charts provide a graphical view of what has happened in the past,
near past, as well as current activity. This information helps traders and investors
anticipate what will happen next.
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Martha Stokes
When you first learn to use a chart, start with the basic layout and learn it
thoroughly before trying to learn the more advanced features of a charting program.
As you become more proficient with chart analysis make sure you customize it
to suit your trading style, parameters, and goals. Try not to fall into the trap of
“following your neighbor”. Each trader is unique and what works for someone else
may not work for you.
Remember, no one can predict the markets. Good chartists study the historical
data as well as the current data, identify the most common reoccurring patterns, and
then act on those consistent patterns, ignoring the atypical patterns. In that way,
their analysis may seem to predict when they are actually going with the flow of the
trend.
Martha Stokes, C.M.T. is the co-founder and CEO of TechniTrader®, an educational firm dedicated to
helping investors and traders. Martha’s fascination with the markets and business started at a very young
age. She made her first investment while still a teen. In her late thirties, when most people are just getting
their careers established, she took an early retirement. Martha considers teaching as a way to enjoy her
retirement while giving something back. Her infectious energy and vast body of knowledge in economics
and financial markets, along with her innate ability to identify newly emerging technology has established
her as a market authority. Her theory on Cycle Evolution is a landmark work on financial cycles. She
has been involved in several startups and has sat on both sides of the Venture Capital negotiating table,
worked on an IPO, managed a small fund, taught at community colleges, and has been a guest speaker
at numerous seminars and investment groups including the Boeing Employees Investment Group. She
has been a guest on the CFRA radio Ottawa Canada. Her long list of educational work include: 15 stock
and option courses, 14 semester length Lab Classes, her Annual New Technology Reports, Sector and
Industry, and Special Edition Reports, hundreds of articles, resource papers, and white papers. Martha
writes 6 newsletters each week and still finds time to answer student questions.