So far, we have introduced almost all of the most popular technical indicators; this article will group these indicators into four major categories and present possible strategies to profit from signals given by a combination of such indicators.
Technical indicators can be defined as overlays on the chart that provide traders with additional information about future price movements. In fact, they can be categorised into four groups, namely trend, momentum, volume and volatility indicators.
1. Trend Indicators
As the name suggests, trend indicators tell us in which direction the price is moving in, given a trend can be identified. They are sometimes known as oscillators, because they tend to oscillate between high and low points, much like a wave. Some of the well-known trend indicators include: Parabolic SAR, Ichimoku Kinko Hyo, and MACD, detailed articles on each of these indicators have been published already and can be found on our education portal.
2. Momentum Indicators
Momentum indicators tell us how strong/weak a particular trend is, and may also provide hints of reversals. Popular momentum indicators include RSI, ADX, and Ichimoku Kinko Hyo.
3. Volume Indicators
Volume Indicators provide insights on change of volume over time, i.e. how many units are being bought and sold at a given time. These indicators become particularly important when prices are changing, as it gives an indication of how strong the move could be. To give an example, bullish moves on high volumes are much more likely to be maintained than those on low volume. We have not introduced any volume indicators on our education portal yet, keep an eye out for future updates! (If you would like to do some research, common volume indicators include: On-Balance volume, Klinger Volume Oscillator etc.)
4. Volatility Indicators
Volatility indicators give us an idea on how much/fast the price is changing, i.e. the range of prices, nothing about the direction. This is a very important element of the market! We need volatility for the price to move, and we need the price to move to generate a profit! The general idea is low volatility means small price moves and high volatility means big price moves.
As you could probably tell from the definitions above, the indicators can be closely related and could complement each other to provide more reliable signals. Each indicator has its limitations and will not be accurate 100% of the times, hence, using multiple indicators could reduce such errors. Let’s look at some possible combinations together.
I. Parabolic SAR and Ichimoku Cloud
On day 1, the price closed below the blue Kijun Sen line, which indicates that the price could move lower. On day 2, the price recovered slightly, however still remaining below the Kijun Sen line (hence still bearish). The Parabolic SAR, on the other hand, is below the candlestick, which is a bullish signal. We have conflicting indicators here. On day 3, the price dropped significantly and is way under the Kijun Sen. The Parabolic SAR has also flipped sides and is now above the candlestick – both indicators showing bearish signals -> short opportunity!
II. RSI and Bollinger Bands
In late October/early November, RSI is seen in the overbought region, which is a selling signal. However, at that time, Bollinger Bands were still expanding, we have conflicting indicators again. In the next few days, the Bollinger Bands started to contract a little, until 5th November, we see a clear contraction in the bands, which matches the signal given by the overbought RSI -> short opportunity.
The above two examples illustrates that combining indicators is a great way to provide more confidence in a position and avoid fake outs. It is essential to be aware that no strategy is bullet-proof, hence we should always manage our risks appropriately. Feel free to try out your own combinations of indicators, see what works for you and what doesn’t, good luck in finding the perfect combination for yourself!