The technical indicator system is a technique for analyzing and predicting trends based on indicators.
Technical indicators are usually presented in the form of charts. Indicators are calculated based on historical parameters such as price, volume, etc. to explain the supply-demand relationship and its impact on prices. From there, predict the trend of money flow and price movement.
There are many indicator systems built and developed such as MA, SMA, MACD, Vol, Bollinger Bands, RSI… Each different calculation and construction formula will produce different groups of indicators. Investors often combine indicators to increase accuracy when analyzing, forecasting, and making trading strategies.
1. Main groups of indicator systems.
The technical indicator system is divided into main groups including:
- Trend indicators are used to assess the current trend and predict future trends. Including lines: MA, MACD, Parabolic Sar, CCI…
- The group of momentum indicators is used to determine the rate of change in price. Including lines: RSI, Stochastic, ROC…
- Volume indicators are indicators that combine price and volume to determine trend strength. Including lines: MFI, OBV…
- A group of volatility indicators is used to determine the trend of price fluctuations. Including lines: Bollinger bands, ATR, ADX…
- The group of support and resistance indicators shows that the price levels on the chart form a barrier/support that causes the stock price to push in a certain direction such as a Pivot point, Donchian channel, etc.
2. Some of the most commonly used indicators.
2.1. Moving Average (MA).
A moving average (MA) is an indicator of a stock’s price trend over a period of time. The moving average is calculated as the average of closing prices over a certain period of time. Normally, the short-term MAs take the 9, 20-day, the medium-term 50-day, and the long-term 100, 200-day.
Besides the MA, you can use some other variations of the MA such as EMA, WMA, etc.
- The exponential moving average (EMA) is calculated using the exponential formula. This line values recent price movements, so it is more sensitive than the MA. Therefore, this line may not be very accurate in cases of erratic volatility.
- The Linear Weighted Moving Average (WMA) values high-volume price moves.
2.2. Moving Average Convergence Divergence (MACD).
Moving average convergence divergence (MACD) is applied to determine the point of convergence and divergence. From there predict the next trend to make accurate trading decisions. The MACD line shows the strength of the trend. The MACD indicator helps traders to better consider entry.
The MACD line is formed from the 12-period EMA and the 26-period EMA. And use the 9 MACD line as the signal line as the comparison line. Therefore, the MACD shows the relationship between two exponential moving averages of a security’s price.
– When the MACD line crosses the MACD 9 line from below, signaling an uptrend.
– When the MACD line crosses the MACD 9 line from above, it signals a downtrend
– In a downtrend, MACD tends to increase or move sideways, it is called convergence. The indicator shows signs of an uptrend.
– In an uptrend, the MACD tends to fall or move sideways, it is called a divergence. The indicator shows signs of a downtrend.
2.3. Bollinger Bands.
Bollinger Bands are one of the most widely used indicators. The Bollinger Band is the interval between the upper and lower Bollinger lines with the MA in between the two Bollinger lines. The wide or narrow Bollinger band shows the strong or weak movement of the market.
When the Bollinger Bands are narrowing, showing signs of high price volatility in the future, prices can reverse quickly. Conversely, the wider the gap between the bands, the higher the probability of selling.
2.4. Relative Strength Index (RSI) line.
The Relative Strength Index (RSI) line is a momentum oscillator that measures the price changes of the most recent trades. The RSI is often used to gauge overbought or oversold at a price.
The RSI is calculated by dividing the average price increase by the average price decrease over a specific period (typically 14 periods) and plotted on a scale from 0 to 100.
– If RSI > 70, it is considered to be in the overbought zone.
– If RSI < 30, it is considered to be in the oversold zone.
– If the RSI is between 30 – 70, it is in the neutral zone.
When using the RSI line, it is common to take the SMA line of the same time frame as a comparison line to give a trend indicator.
- RSI < 30: Buy when the RSI line crosses below 30, forms a bottom, and then turns up and crosses 30.
- RSI > 70: Sell when the RSI line crosses above 70, forms a peak, and then turns down to cross 70.
- 30 < RSI < 70: Sell when the RSI line crosses the SMA from above and continues to go down. Buy when the RSI line crosses the SMA line from below and continues up.
2.5. On balance volume (OBV) indicator.
The On balance volume (OBV) indicator is an indicator to measure the amount of supply and demand in the market over a period of time. This indicator uses changes in volume to confirm price changes. The OBV indicator is represented as a cumulative line.
How to calculate the OBV index:
– If the price rises, OBV equals the previous OBV plus the trading volume of the session.
– If the price falls, OBV equals the previous OBV minus the trading volume of the session.
– If the price does not change, OBV stays the same.
Analysts use the OBV indicator to confirm market trends.
- When the OBV line increases, it shows that the buying power is higher than the selling force, and the price tends to be pushed up.
- When the OBV line decreases, it shows that selling is higher than buying power, and prices tend to be pushed down.
In addition, when the OBV indicator and price move in different directions signals a trend reversal.
- When the OBV line rises, the buying force is dominant but the price decreases, this shows that the downtrend of the trend is weakening, predicting that the price will reverse to create an uptrend.
- When the OBV line decreases, the selling force is dominant but the price increases, this shows that the uptrend of the trend is weakening, predicting that the price will reverse to create a downtrend.
2.6. Money flow index (MFI).
The Money flow index (MFI) is an indicator of the strength of money flow over a period of time. The MFI shows how quickly money is poured into an asset and withdrawn afterward.
The MFI indicator was developed based on the RSI but added a volume element.
The MFI indicates that when the market makes a top or bottom, the volume of transactions there will increase. Therefore, based on price changes alone, it is not possible to accurately reflect the whole market.
The MFI is represented as an oscillating line in the range of 0 – 100. However, analysts often set the threshold of 20 – 80 to determine the oversold or overbought threshold.
– An increase in MFI shows that the buying force increased compared to the selling force. A decrease in MFI indicates an increase in selling compared to buying.
– If MFI > 80 is considered to be in the overbought phase. If MFI > 80 is in an uptrend, it signals that the market is about to correct down or reverse to create a downtrend.
– If MFI < 20 is considered to be oversold. If MFI < 20 in a downtrend, it signals that the market is about to correct up or reverse, creating an uptrend.
In addition, the MFI indicator signals a trend reversal when the MFI and price move in different directions:
- When the MFI increases, the buying force is dominant but the price decreases, predicting that the price will reverse to create an uptrend.
- When the MFI decreases, the selling force is dominant but the price increases, predicting that the price will reverse to create a downtrend.
Above are the basic contents and some of the most commonly used indicators in technical indicator systems. Each indicator has its own advantages and disadvantages. To increase efficiency when using the technical indicator system, investors need to choose the right indicators for themselves and combine the indicators with each other or with other technical methods.
Wishing you to gain basic knowledge and effectively use the technical indicator system in your trading.