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What are trading indicators?

What are trading indicators?

In India, many traders who trade on the NSE, BSE and MCX use trading indicators to make their trading decisions. You must have seen a price chart–it basically plots where price has been in the last few hours, few days, weeks and even months. Now with the help of some calculations we can derive certain trading indicators to help us make a better decision when trading. It’s important to remember that indicators are a derivative of price, meaning they derive their values from price action.
Dividing these indicators into two distinct parts makes it easy to understand their functions. They are ‘Overlay’ indicators which are overlaid right on top of a price chart and plain o’l indicators that are placed below the price chart.

Price Chart

This is a Chart of Larsen and Toubro without any indicators, it displays only price.

Overlay Indicator

This is the same chart with an ‘overlay’ indicator called the moving average, that red line running across the price chart measures the average price over a certain period of time. We’ll talk in more detail about moving averages in a separate dedicated article.

Indicators

Notice the ‘extra’ chart below the price chart of Larsen & Toubro? That is an indicator called the MACD (pronounced ‘MAC’ ‘dee’ or simply the MACD) and it measures momentum. It uses moving averages to use both of best worlds, momentum and trend following.

 

Broad Market Indicators

These kind of indicators are not placed on price charts. Broad market indicators give us vital information about market depth and broad range movement. If you ever tuned into your favourite financial news channels you have probably come across the market breadth ‘Advance – Decline’ ratio/line. This indicators basically tells us how many stocks are positive V/s companies which are trading in negative territory all calculated over current price subtracted from the previous day’s close.

This chart measured the Advance to decline ratio on the broad market at 1pm on 8th May 2014. We can see that the market is turning negative. We have 682 declining stocks and 611 stocks that are higher than yesterday’s close. Can you guess how many points nifty would be up with such figures?
Yes that’s right – The markets are in doldrums since the number of stocks advancing and declining is roughly the same (a difference of 70 is not much) – they are in a no movement zone. Nifty was up by a mere 0.80 points (that is not even 1 point) or +0.01%.

Broad market indicators give us vital information about the broader markets and can be seen as an overview of what markets are generally doing.

The Pros and Cons of using Indicators

The Pros of using indicators

  • Since many people using indicators it is likely a good starting point to learn technical analysis
  • Beginners find it difficult to judge trend, overlay indicators provide an easy to follow way to follow the trend without thinking too much
  • Most indicators derive their values from PRICE which is the leading indicator to anything, it reflects the exact demand and supply live.
  • Charting is inexpensive, for traders who have accounts with us at RKSV – our NEST terminal allows free access to charting.
  • Charts provide a wealth of information, any news out there in the world will reflect in price immediately, that data can be used directly to help us trade & invest better.

The Cons of using indicators

  • Indicators are usually lagging, even if we use leading indicators they will still always precede price movement. Indicators are usually ‘too late’ to the party.
  • Indicators are probably the most used technique in the world but professional traders usually concentrate on price action trading because they consider technical indicators to be lagging and not provide a meaningful edge.

 

Prateek Singh is the author of this article and wants to know if you found this helpful, use the buttons below to let us know and don’t forget to share this with your friends on Facebook, Twitter or LinkedIn!

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