Technical Indicator

Technical indicator is a type of analysis tool that indicates or predicts the market direction. A technical indicator makes mathematical transformation of prices (or other indicator result) into a set of numbers and, being easier than prices to understand, reveals market tendency. Indicators, in the right hands, are useful and important tools but they are not perfect. Besides, no indicator is suitable for all market conditions.

Indicator vs. Oscillator

Depending on the range of values an indicator provides, it is can be referred to as an indicator or an oscillator:

• Indicator has a range of values which is comparable with the range of prices, and, therefore can be drawn on the chart. For example, Simple Moving Average:
  
• Oscillator has a range of values which greatly differs from the range of prices, and, therefore, must be drawn on a separate chart. For example, Relative Strength Index (RSI):
  

Trend, Momentum and Volatility Indicators

A market can be:

• Trending when there is a certain trend in the price, that is the price is gradually moving up or down during a long time period.
• Ranging when there is no trend, that is the price moves up for a short time and then moves down for a short time, and vise versa.

It is important to identify whether the market is trending or ranging and to employ indicators suited to the purpose. Chart signals often conflict and it is difficult to separate the trend from the surrounding 'noise'.

Trend indicators attempt to provide an objective measure of the direction of the trend. Price data are smoothed and the trend is represented by a single line. Because of the smoothing process the indicators tend to lag price changes. Signals of trend indicators are reliable in trending markets. In a ranging market, trend indicators lose money, as fluctuations in a narrow price range whipsaw traders in and out of positions.

If a market is ranging, momentum indicators which indicate short-term price movements should be used. In a trending market, momentum indicators give signals too early and should only be used to confirm trend indicators.

There are also volatility indicators which, as the name supposes, show market volatility. These indicators can be used in a trending as well as in a ranging market.

See Also

• Indicators Category
• StockCharts.com - Introduction to Technical Indicators and Oscillators