Technical indicators explained
The final part of a technical trader's toolkit that we're going to cover in this course is the technical indicator.
What are technical indicators?
Technical indicators are tools you can apply to a market’s chart that use mathematical calculations and formulas to give you extra insight into its price movements. Instead of relying on the patterns formed by an asset’s live price, they offer an additional dimension to assist in making trading decisions.
There are hundreds of technical indicators you can use when trading, and more are created all the time. However, they fall into two main categories: trending markets and non-trending markets.
Technical indicators for trending markets
Technical indicators for non-trending markets
Indicators for trending markets help you stay on the right side of an asset that is on a bull or bear run.
Examples: Moving Averages, MACD
Indicators for non-trending markets can signal when an asset is overbought or oversold in the short term.
Examples: Stochastic Oscillator, RSI
Lots of traders will use technical indicators to refine their timing. Others will use them to determine the strength of prevailing trends, so they can decide whether the opportunity is worth the risk.
Essentially, most indicators take complex calculations and automate them on your chart. While the formulas themselves may be tricky to understand, the art is learning how to interpret the signals they generate.
Do you need technical indicators?
To some technical traders, indicators are everything. They don’t believe that a chart can be called a chart without extra bells, whistles, and lines attached.
That isn’t the case, and many experienced investors can read price action without any enhancements. However, indicators can offer a useful method of analyzing markets and finding new opportunities.
Drawbacks of using technical indicators
As technical indicators derive their figures from a market’s price, most will be lagging or backwards-facing by their nature. By the time you come to apply their results to a live trade, the opportunity may have passed. Like any trading tool, they are not 100% effective and should be used with caution.
Plus, indicators are usually subjective – two traders may well derive completely different conclusions from the same one.
We’re going to take a look at three commonly used indicators in the next lesson, but before we do that let’s take a look at the most popular one of all: moving averages.