Charts are known as a trader's visual diary. As a trader, you can keep these cues in store and track market movement in real-time.
How would you know when is the right time to enter the market and when’s a good time to gather up your profits and exit? For the short-term you might want to use the zoom lens and focus on the ongoing ups and downs in the market. However, the question remains—how will that help your decisions in the future?
What is a trading indicator?
Indicators, just like the name suggests are a simple way to help you identify these points. They tell a trader to buy, sell or just stay put at a particular point in time in the financial markets. Indicators are mathematical ways in which you can get a better idea about market behavior.
The origin of indicators can be traced back to 1901 when traders used to take an average of the prices of a particular stock at the end of the day’s trading. It came to be known as the closing price. An average line was drawn across the chart tracing each day’s closing price. That was the first indicator used in trading.
Types of trading indicators:
Leading indicators
A leading indicator relies on previous price action in order to predict future price movement. They are essentially predictive in nature. Because they are predictive in nature, the trends predicted by these indicators might turn out to be true or they might not. There’s a certain element of risk associated with leading indicators.
Let’s use a non-financial example to understand how indicators work. Think of a tug-of-war match. You have the buyers on one team and sellers on the other. Based on the teams’ track record, recent performance, weather and soil on the playground, you decide that Team Buyers is more likely to win in these conditions.
When is the best time to place your bets? That’s the question that leading indicators help intraday traders answer. Since it is predictive in nature, such indicators are designed to inform traders about upcoming trends. Intraday traders can maximize short-term profits by using leading indicators to get a prior idea of what might happen in the future.
Examples:
- Relative Strength Index(RSI)
- Stochastic
- Parabolic SAR
Lagging indicators
Lagging indicators are those that calculate a particular trend just a little bit after the trend has already started. These indicators want to make sure that the trend is true prior to sending signals to market participants. These types of indicators measure the vertical price movement i.e. the up and down oscillation that happens in a stock price.
Such indicators are useful in a trending market as compared to leading indicators that are useful in a sideways market.
Examples:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Moving Average Convergence Divergence (MACD)
A trending market happens when a market is headed in one direction—a bullish market is the one that trends upwards while a bearish market is the one that trends downwards. Lagging indicators track patterns of upward and downward movements of the market.
A sideways market, on the other hand, is the one where price movement is not high enough. There’s very little movement and that’s why there are no distinct trends that can be observed.
A recap:
Features of Leading Indicators:
- Buy/Sell signals are generated based on up and down oscillation of prices.
- Predict upcoming trends
- Useful in sideways markets
- Good for trading on shorter time frames
Features Lagging Indicators:
- Generate Buy/Sell signals based on horizontal movement of vertical price oscillation
- Confirms unfolding trend
- Trending markets
- Good for positional and swing trading over a period of time
Upstox offers more than 100 indicators both on Upstox Pro web and Upstox Pro mobile. If you’re interested in learning about feature updates from Upstox, subscribe here and we’ll keep you posted regularly!
You can learn how to use different types of indicators from Trade Academy, Upstox’ educational arm. To never miss a trading opportunity, download TA Scanner!
*This information was first presented in a video hosted on TradeAcademy by Prateek Singh, Trade Academy is our educational arm that holds online classes to make you a better trader. Check out the video here.