# Indicators

## Technical Analysis Indicators

Technical Indicators are another way to look at a stock price movement. As the name goes, technical indicators indicate the price action happening in a stock. Technical Indicators broadly serve three functions: to alert, to confirm and to predict.

As with any other technical tool, indicators alone cannot be used to initiate a buy/sell position. The buy and sell signals generated by the indicators, should be read in context with other technical analysis tools like candlesticks, trends, patterns etc.

**Types of Technical analysis Indicators:**

**Leading Indicator: **

Indicators under this category signal early entry and exit. Leading indicators are designed to lead price movements. Some of the popular leading indicators include Commodity Channel Index (CCI), Momentum, Relative Strength Index (RSI), Stochastic Oscillator and Williams %R. ** **

**Lagging Indicator: **

Indicators under this category follow a trend rather than predicting the future price movement. Lagging indicators work well when prices move in relatively long trends. Buy and sell signals given by these indicators are late and some traders may miss the early entry opportunities. Moving averages and the MACD are examples of trend following, or “lagging,” indicators.

**Moving Averages: **

A moving average is the average price of a security at a given time. A moving average is calculated by using close price of a security. When calculating a moving average, number of periods to look back is taken as input. For example a 14 day moving average uses closing price of previous 14 days.

Calculating a moving average is nothing but taking average of close prices over number of days provided as input. Consider the following closing prices registered by a stock

Day 1 | 50 |

Day 2 | 60 |

Day 3 | 65 |

Day 4 | 70 |

Day 5 | 60 |

Now on Day 6 the moving average is calculated in the following way (50+60+65+70+60)/5 = 61.

**“Simple Moving Average”** is the term used to calculate the Traditional way of Moving Average.

**Exponential Moving Average:**

In calculating a simple moving average, weightage given to all close prices is equal. In order to reduce the lag in simple moving averages, technicians apply more weight to the recent prices relative to older prices. This method of calculating a moving average by applying more weight to recent prices relative to older prices is called as exponential moving average.

As shown in the figure below, exponential moving average reacts faster to the price movement than simple moving average.

EMA (current) = ((Price (current) – EMA (prev)) x (Multiplier) + EMA (prev)

Multiplier = 2/(time period + 1)

Don’t worry much about the exponential moving average calculation. Many of the charting platforms provide the tool directly.

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**Oscillators:**

Indicators under this category have value which oscillates between two values across a reference line. Most of the indicators oscillate between 0 and 100 and some of them oscillate between 0 and 1. Some of the indicators which fall under this category are Relative Strength Index, Stochastic, and Rate of Change etc.

**Relative Strength Index:**

RSI is a momentum oscillator which oscillates between 0 and 100. The word momentum indicates the speed with which the price moves. It is believed in the trading world that price falls/rises from a certain point with the same pace with which it has reached that point.

When the value of RSI reaches above 70, the stock is said to be over bought. Similarly when the value of RSI reaches below 30, the stock is said to be over sold. During strong trends, the RSI may remain in overbought or oversold for extended periods.

In an uptrend or bull market, the RSI tends to remain in the 40 to 80 range with the 40-50 zone acting as support. During a downtrend or bear market the RSI tends to stay between the 0 to 60 range with the 50-60 zone acting as resistance.

**Bearish Divergence:** If the underlying price makes a higher high but the RSI makes a lower high, it is termed as Bearish Divergence. This is a signal for trend reversal and price may turn bearish.

**Bullish Divergence:** If the underlying price makes a lower low but the RSI makes a higher low, it is termed as bullish divergence. This is a signal for trend reversal and price may turn bullish.

**Stochastic Oscillator:**

Stochastic Oscillator compares the closing price of a stock to its lowest low and highest high over a specified period.

Here Stochastic is designated by %k.

For example, if today’s close is 50 and high and low over last 14 days is 40 and 55 respectively then,

%k is then multiplied by 100 to arrive at a final value. So, the final value would be 66.6%. This 66.6% signifies that today’s close was at 66.6% level relative to its trading range over a period specified.

The other input for a stochastic oscillator is %D which is nothing but a simple moving average of %k over a period which usually is 3.

Similar to RSI, stochastic also moves in between 0 – 100. Any value above 80 is considered overbought and value below 20 is considered as oversold.

**MACD:**

MACD stands for Moving Average Convergence Divergence. This indicator consists of two moving averages and the distance between them. For calculation purpose MACD uses exponential moving averages

**Components:** Fast Line, Slow Line and Histogram.

**Fast Line Components:** 12 periods EMA, 26 Period EMA and difference between 12 and 26 periods EMA. Using the above components a “Fast Line” is calculated.

**Slow Line Components: **9 period EMA of Fast Line

MACD takes into account the aspects of both momentum and trend into one indicator. Exponential moving Average helps in following the trend whereas Bullish and Bearish Divergences signal the trend reversal.

Range of MACD depends on the value of the stock. This is the reason that, only centre line crossover is taken into account to judge whether the stock is bullish or bearish

**Bearish Divergence:** If the underlying price makes a higher high but the RSI makes a lower high, it is termed as Bearish Divergence. This is a signal for trend reversal and price may turn bearish.

**Bullish Divergence:** If the underlying price makes a lower low but the RSI makes a higher low, it is termed as bullish divergence. This is a signal for trend reversal and price may turn bullish.

**Bollinger Bands:**

Bollinger Bands is a mix of technical analysis and risk management. Bollinger Bands has 3 bands in it. The middle band is the 20 period Simple Moving Average. Upper band is the 2-standard deviation above it and the lower band is the 2-standard deviation below it.

Including 2 standard deviation makes Bollinger Bands more dynamic and adaptive to volatility. In a sideways market, upper band acts as resistance and lower band acts as a support.