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Technical Indicators Defined & Explained Technical Indicators Defined & Explained A guide to understanding and applying the most popular technical indicators by BDSwiss Trading Academy Any information appearing on this graph or text is based solely on reasonable assumptions and does not December 2020 represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. Index Page 01 RSI - Relative Strength Index 03 02 Average Directional Index 07 03 Parabolic SAR 10 04 Moving Average Convergence and Divergence MACD 13 05 Bollinger Bands® 16 06 Linearly Weighted Moving Average 19 07 Exponential Moving Average 22 08 Simple Moving Average 25 09 Stochastic Oscillator 28 Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 2 01 RSI Relative Strength Index Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 3 Indicator Profile • RSI was developed in 1978 by J. Welles Wilder Jr. • It is among the most widely used trading indicators in technical analysis. • RSI is a momentum indicator, which means it helps measure the velocity of a particular assets price changes. • In its initial form, the RSI was designed for stock trading. As it started proving efficient, traders began applying it to other assets as well. The Relative Strength Index is an indicator that helps traders capture market momentum by measuring the magnitude of price fluctuations. Traders use RSI to recognize oversold and overbought markets and decide on when to open a position. The RSI takes the form of a line between two extremes (also known as an “oscillator”). It can have a value between 0 and 100. The RSI is estimated on the scale from 0 to 100. The traditional interpretation of the Relative Strength Index supposes that anything above the value of 70 indicates that the given asset is overvalued and the market is overbought. On the contrary – assets with RSI below 30 are considered undervalued and their market – oversold. Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 4 What is Overbought and Oversold? Once we use the RSI to identify an oversold or an overbought asset, then we can expect a trend reversal or a correction and capitalize on it. Oversold signals suggest that the selling pressure in the given asset is easing, and the traders should brace themselves for a potential rebound. Overbought signals, on the contrary, indicate the momentum when the asset is reaching its maximum levels for bulls and could soon experience a correction. Buy Signals The Bullish Oversold Signal is a trend reversal signal that occurs in situations where the RSI falls below 30% and bounces back. There is no difference in how low it will go. The important thing here is for it to rise again above the 30% mark. Once it does, it is an indication that bulls are taking over, and a new upwards trend may be forming. The Bullish Divergence Signal is another trend reversal signal that occurs when the RSI and the price divert from each other. This happens when the price makes a lower low while the RSI marks a higher low. Depending on the number of times this event repeats, this could indicate the strength of the forming signal (the more, the better for the bulls). This comes to show that it is imperative to look at both – the RSI and the price movement. Sell Signals The Bearish Overbought Signal indicates when a trend reversal may take place. To spot such an indication, make sure to look for situations where the RSI surpasses the 70% mark and then falls back below it. This could indicate that the bears are getting stronger, and a trend reversal is about to take place soon. The Bearish Divergence Signal is observed when the RSI marks a lower high, and the price marks a higher high. Once again, the more repetitive this process is, the stronger the upcoming bearish signal will be. This is another trend reversal signal that confirms the importance of taking into account both the RSI and the price movements and not analyzing any of them in isolation. Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 5 Calculations The relative strength index (RSI) is computed with a two-part calculation, starting with the below formula: The average gain and loss used in the calculation is the average percentage gain and loss during a pre defined period, using a positive value for the average loss. As a standard 14 periods are used to calculate the initial RSI value. For example, imagine the market closed higher seven out of the past 14 days with an average gain of 1%. The remaining seven days all closed lower with an average loss of -0.8%. The calculation for the first part of the RSI would look like the following expanded calculation: Once there are 14 periods of data available, the second part of the RSI formula can be calculated. The second step of the calculation smooths the results. Using the formulas above, RSI can be calculated, where the RSI line can then be plotted beneath an asset’s price chart. The RSI will rise as the number and size of positive closes increase, and it will fall as the number and size of losses increase. The second part of the calculation smooths the result, so the RSI will only near 100 or 0 in a strongly trending market. Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 6 02 Average Directional Index Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 7 Indicator Profile • The Parabolic SAR is a technical analysis tool developed by J. Welles Wilder Jr., the creator of the RSI. • The ADX is a trend indicator and is shown as an oscillator in a window below the pricing chart. • Despite its name, this indicator doesn’t give you any information about trend direction. It will show the strength of the trend. As with many trend indicators, ADX lags behind the price, so is not useful if you want to get in on trends early. But it is useful if you only want to trade strong trends. Combined with a directional trend indicator, such as Parabolic SAR, ADX can confirm that a trend is strong and is going to continue. This should give you more confidence when entering into a position. When showing a between 0-25, this usually signals a weak trend, when the readings are between 25 and 50, this shows a strong trend, any readings above 50 indicates a very strong trend. Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 8 Average Directional Index calculation The ADX oscillator’s values are calculated automatically using the following formula: ADXi = EMAi x ( | DMI ( + ) - DMI ( - ) | / ( DMI ( + ) + DMI ( - ) ) x 100 ADXi is the Average Directional Index value of the period being calculated. EMAi is the Exponential Moving Average value of the period being calculated. For more information. DMI(+) is the positive Directional Movement Index value of the period being calculated. For more information. DMI(-) is the negative Directional Movement Index value of the period being calculated. Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 9 03 Parabolic SAR Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 10 Indicator Profile • The Parabolic SAR is a technical analysis tool developed by J. Welles Wilder Jr., the creator of the RSI. • They are used to determine the price direction of an asset. It also draws attention to when the price direction is changing. • The Parabolic SAR is also referred to as the Stop and Reversal system. The Parabolic SAR is a trend indicator. Dots are placed on the chart either above or below the price, as they indicate the potential direction of the price movement. When the dots are above the current price, this indicates that the market is in a downtrend. Traders can use this to short or sell. When the dots are below the price, the market is in an uptrend, indicating that you should go long or buy. Any information appearing on this graph or text is based solely on reasonable assumptions and does not represent a reliable indication of future performance, nor does it represent a recommendation for trading decisions. 11 The Parabolic SAR should not be used in a ranging market. When the markets are moving sideways there will be lots of noise and this will make the dots flip from one side to the other providing no clear trading or false signals.
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