Indicators and Oscillators
Anyone hoping to enter the world of trading may find themselves bewildered by the vast array of jargon that is casually thrown around. However, in reality the concepts are not that difficult to grasp.
Indicators and oscillators is a phrase often heard in the market and is a fundamental part of technical analysis. But what exactly are they and how are they used?
The Basics
A technical indicator is simply a data point that is calculated by manipulating information to try to ascertain a pattern or relationship. By creating a series of different data points spread out over a period of time, a technical analyst can try to predict how the market might move.
Indicators can serve different functions. Firstly, they can be used as an early warning system to alert the trader that a particular trend or price action warrants closer attention. For example, they could highlight the fact that a breakout is about to occur or possibly a retracement in the market. Secondly, they can help to confirm suspicions raised by other available tools. Some traders also use indicators to try to predict future price movement, but this is not universally used by everyone.
Despite having a flashy sounding name, an oscillator is simply a type of indicator and one that wavers between given values.
From Stochastics to Bollinger
There are different kinds of indicators and oscillators but overall, they can be separated into two main groups, namely leading and lagging.
Leading indicators are designed to give an early warning of the likely price movement, helping the trader to predict how the market will swing. Most leading indicators used by traders are oscillators.
Common leading indicators are the Stochastics Oscillator and the Relative Strength Index.
The Stochastics Oscillator helps to determine whether the market is in the midst of an upward trend or a downward movement. It does this by comparing the closing price to a range of prices over a specified period of time. The trader can set the time scale they want. The theory behind this indicator is that an upward trending market will close reasonably near to their high, but a downward trending market will stick to the bottom end of the price range.
The Relative Strength Index is viewed by many as a more volatile tool and one that should be used to confirm the signals from other indicators. The system compares the size of recent gains to losses to try to determine whether an asset is being over-bought or over-sold. This in theory helps to identify a trend and also to show when a retracement is likely to occur.
Conversely, lagging indicators have few predictive qualities but nevertheless form an important part of helping to determine a trend. Bollinger bands are one of the best known lagging indicators and used widely. They help to identify volatility and can mark a sharp imminent change. They work by plotting either side of a basic moving average using two deviation points. If the band tightens it can be an indicator that volatility is about to swing upwards. If prices start to move towards the upper band, the analyst will treat the market as over-bought and the lower band signifies over-selling. Both indicate a possible correction is due.
In Practice
The use of oscillators and indicators is commonplace in trading but undoubtedly takes time and practice before they can be easily read. Some traders rely on them more than others but having at least some indicators in your repertoire is a handy tool to fall back on.
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