Section 4: Basic Indicators
While price patterns are constructed through the direct observation of price movements, Indicators are derived from the price data and plotted separately, usually on the same time scale but either above, below or as an overlay on top of the price chart. Some indicators measure average prices and others show the momentum, or rate of acceleration, of recent price history. There are also important Market Indicators that evaluate the strength of broad indices.
The use of moving averages is likely the most simple and useful way to mathematically evaluate the direction and strength (momentum) of a price trend. We first evaluate the types and various uses of moving averages.
The concept of price momentum is simple, but its application can involve difficult calculations when applied in specialized situations. The use of Oscillators that are derived from the price data is the most common way to measure momentum. Essentially we are aiming to evaluate the current strength of the trend in relation to its past performance. When a trend is mature, price momentum typically slows and can therefore be an early warning of an impending trend change. The more common oscillators are included here.a
While oscillators measure the strength of the trend’s direction, volatility measures the dispersion of prices over time. This can be an important clue into the usefulness of price patterns, moving averages and momentum indicators, as a high degree of volatility can indicate a less reliable technical signal may be given. Also, high volatility correlates with indecision and confusion on the part of market participants, which could be interpreted as a sign of a weakening trend.
Trading volume related indicators can also be used to signal the strength of trend, or lack thereof. If the trend is strong, trading volume should confirm the price action. When it does not, it is a warning sign that a trend change could occur soon.
Separate from individual stock indicators, these are specific to certain Exchanges (such as the NYSE) or broad market indices (such as the S&P 500 Index) and can be used to evaluate the health of the overall market.